Title
Liquidity, Downside Risk, and Asset Pricing: Evidence from Pakistan’s Stock Market
Authors
Abstract
The purpose of this study is to extend the Fama & French three-factor model to a six-factor model by incorporating stock liquidity and Value at Risk (VaR), to capture the vulnerability of emerging markets such as Pakistan. The database from the Pakistan Stock Exchange, along with balance sheet analysis from the firm level provided by the State Bank of Pakistan from 2015 to 2024, was used to investigate the explanatory power of the extended model based on regression analysis. The findings demonstrate that more liquid stocks will have lower risk premiums and are therefore more attractive to investors, and firms with lower VaR will yield consistent returns. On the other hand, firms with a higher VaR will yield more returns, but with added downside risk. Hence, the model improved on the asset pricing abilities by including liquidity and VaR, making it more pertinent for risk-adjusted decisions for global investors, enhancing risk management frameworks for financial institutions, and developing regulations that augment market efficiency and regulation for policymakers. The research highlights the relationship between liquidity and downside risk in asset pricing, supporting the growing research on emerging markets, and recommends considering more macroeconomic factors, such as ESG factors, interest rates, and monetary policy, while testing the model in other emerging economies.
Keywords
Stock liquidity, Value at Risk (VaR), Asset pricing models, Fama-French models, Pakistan Stock Exchange
JEL Codes
G12, G15, C58, O16
How to Cite
Dua-e-Zahra, S., & Mubashar, A. (2025). Liquidity, Downside Risk, and Asset Pricing: Evidence from Pakistan’s Stock Market. The International Journal of Finance, 37(1), 39–61.