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Open AccessArticle

Size, Value and Business Cycle Variables. The Three-Factor Model and Future Economic Growth: Evidence from an Emerging Market

1
College of Economics, Zhejiang University, Hangzhou 310027, China
2
School of Business, Hong Kong Baptist University, Kowloon 999077, Hong Kong, China
*
Author to whom correspondence should be addressed.
Economies 2018, 6(1), 14; https://doi.org/10.3390/economies6010014
Received: 1 November 2017 / Revised: 14 February 2018 / Accepted: 14 February 2018 / Published: 28 February 2018
(This article belongs to the Special Issue Efficiency and Anomalies in Stock Markets)
The paper empirically investigates three different methods to construct factors and identifies some pitfalls that arise in the application of Fama-French’s three-factor model to the Pakistani stock returns. We find that the special features in Pakistan significantly affect size and value factors and also influence the explanatory power of the three-factor model. Additionally, the paper examines the ability of the three factors to predict the future growth of Pakistan’s economy. Using monthly data of both financial and non-financial companies between 2002 and 2016, the article empirically investigates and finds that: (1) size and book-to-market factors exist in the Pakistani stock market, two mimic portfolios SMB and HML generate a return of 9.15% and 12.27% per annum, respectively; (2) adding SMB and HML factors into the model meaningfully increases the explanatory power of the model; and (3) the model’s factors, except for value factor, predict future gross domestic product (GDP) growth of Pakistan and remain robust. Our results are robust across sub-periods, risk regimes, and under three different methods of constructing the factors. View Full-Text
Keywords: emerging markets; KSE Pakistan; three-factor model; size and value premiums; future economic growth emerging markets; KSE Pakistan; three-factor model; size and value premiums; future economic growth
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Ali, F.; He, R.; Jiang, Y. Size, Value and Business Cycle Variables. The Three-Factor Model and Future Economic Growth: Evidence from an Emerging Market. Economies 2018, 6, 14.

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