Multidimensional Liquidity and Momentum Augmented Fama and French (2015) Five-factor Model: Evidence From Pakistan

Abstract

Using a large sample size of 521 firms, this study is the first to evaluate and compare the performance of five prominent factor-pricing models in PSX: the CAPM, Liu's two-factor model, Fama-French three-factor model, Carhart fourfactor model, Fama-French five-factor model, and both liquidity and momentum augmented Fama-French five-factor model (seven-factor model) using monthly data from January 2002 to December 2020. The results revealed that the value factor is not redundant in the market. The factor-spanning test confirmed that liquidity and momentum are essential augmentations to FF-5FM by producing statistically significant intercepts in both factor regressions. Similarly, the liquidity and momentum augmented FF-5FM outperforms, even though the absolute average alpha of the GRS test implies that the seven-factor model offered a better explanation. This confirms the spanning tests by demonstrating that when combined with FF-5FM; both factors enhanced the specification's prediction power. Liu's (2006) two-factor and Liquidity enhanced FF-5FM are justifiably the next two superior explanatory models proposed by the GRS test.