Size and value premium in Pakistani equity market

This study examined the relationship among size premium, value premium and equity returns in Pakistani equity market for the period of June 2000 to June 2007 by using Fama and French (1992, 1993) methodology. This is the first study in Pakistan that explores the relationship among stated variables by employing a large sample of more than 250 stocks listed at the Karachi Stock Exchange. An analysis of the results reveals that size and book to market ratio are priced by market. Size factor is found significantly positively related to portfolio returns at 95% confidence interval. Book to market factor is also found significantly positively related to portfolio returns. Traditional CAPM is found valid as market factor is significant factor in explaining portfolio returns. However, explanatory power of Fama and French three factor model is 15% higher than explanatory power of conventional capital asset pricing model (CAPM). These results are in line with empirical results reported by Iqbal (2004) and Nawasish (2008 for the Pakistani market and are also in broad agreement with studies that report the validity of Fama and French the three factor model in emerging markets. As size and value premium exist in equity markets so decision makers should consider these factors in making decisions regarding investment, financing and valuation of financial instruments. These results are important, in the sense, that these can facilitate investors in efficient resource allocation.