Human Capital-Based Four-Factor Asset Pricing Model : Evidance from Emerging Economy

The purpose of this study is to extend the Fama-French three-factor model to include the labor-income growth rate (human capital) in Pakistan's stock market from June 2010 to June 2020 as the fourth factor. To this end, we collected data from 164 non-financial companies listed on the Pakistan Stock Exchange (PSX). Additionally, we construct a set of eight portfolios sorted by size, value, and labor-income-growth rate (a proxy for human capital). To evaluate the validity and applicability of the augmented human capital four-factor model, we empirically estimate it using a two-pass time series regression method developed by Fama-Macbeth’s (1973). The empirical results of this study show that small-size portfolios have significantly report more returns than large-size ones. The stocks having lesser market-to-book ratios provid less returns as compared to stocks with higher book-to-market ratios. The study found substantial impact of human capital factors for most of the constructed portfolios, it leades meaningful interpretation of time-series variability in portfolio returns. The findings explain that four-factor model is appropriate asset pricing model used for evaluating the time series changes of asset returns. The empirical results motivate scholars and investors to consider human capital in investment decisions