Relevance of Leverage and Profitability in Risk-Return Paradox: A Study from Pakistan Stock Exchange

Abstract

The purpose of this investigation has to investigate the degree of relevance of these components in the domain of asset pricing by augmenting the basic FF-5 factor model with leverage and profitability that whether leverage-profitability dumping portfolios capturing the return by this model. We performed the five-factor model of Fama-French to capture the joint effect of variables and augmented it with leverage and profitability for the Pakistani market utilizing current periodic month-to-month data from the year 1998 to the year 2019. Construction of factors (MKT, SMB, HML, HLMLL, and RMW) is done for the PSX market and scrutinize that how much this five-factor augmented model detentions the returns premium in the Pakistani equity market. To analyze the model experimentally that consolidate subgroups of its factors that explain the portfolio's normal returns are outlined to make tremendous spreads in size, B/M, leverage and profitability and to capture the pattern for observing their imperativeness, 2X2X2X2 sorted version is adopted to construct the factors. Investigation documents the significant evidence on the leverage and profitability premium. Taking a glimpse at the variables alone, the recently presented leverage and profitability factors show alluring, measurably critical returns for a long/short basis for the Pakistani equity market.