Testing Illiquidity and Momentum Factors with Asset Pricing: Evidencefrom Emerging Capital Markets of South Asia

Abstract

This paper explores the asset pricing factors whichpose aggregate risk tothe portfolio returns in the Pakistan Stock Exchange(PSX).The purpose is to test the illiquidity and momentum factors along with the well-documented three factors in asset pricing model using Fama and French (2015) and Lam and Tam (2011) for one of the emerging markets of South Asia, i.e., Pakistan, using 20-year monthly datafrom January 2001 to December 2020.This paper adopts the methodology of Fama and French (2015) as used in the developed market and Lam and Tam (2011) for the emerging market phenomenon,to formulate the portfolio returns based on Size, Book-to-Market(BM), and the Liquidity,and test these returns against the factors causing thereturnvariations. The results based onthe 3-factormodel, liquidity-adjusted model, and the momentum-based model validate factors ofexcess market return (CAPM), size, value, liquidity, and momentum assignificant risk factors in explaining the variations in portfolio returns of PSX stocks. The portfolio access returns for PSXstocks are adjusted for risk factors with mixed significant response holding average explanatory power. Our results are robust to the GRS F-test