Degree

Master of Science in Finance

Department

Department of Finance

School

School of Business Studies (SBS)

Date of Submission

Spring 2025

Supervisor

Dr. Mujeeb U Rehman Bhayo, Assistant Professor, Department of Finance, Institute of Business Administration (IBA), Karachi

Submission Type

Research Project

Document Type

Restricted Access

Pages

ix, 46

Keywords

Beta Anomaly, CAPM, Idiosyncratic Volatility, Fama-Macbeth Regression, Portfolio Returns, Non-Linearity

Abstract

This study investigates the presence of the beta anomaly in the Pakistan equity market, by empirically testing the efficacy of the Capital Asset Pricing Model (CAPM) in explaining the risk-return dynamics within the Pakistani equity market. Utilizing the Fama-MacBeth (1973) methodology, the monthly returns of 90 actively traded stocks are analyzed from January 2005 to December 2020, distributing stocks into beta-sorted portfolios, that are dynamically updated each month and returns are calculated using both equal-weighed and value-weighted methods. The study reveals a non-linear and complex relationship between beta and returns, significantly impacted by idiosyncratic volatility, underscoring the presence of a beta anomaly. When controlled for size, the anomaly persists across large-cap and small-cap stocks, indicating that market inefficiencies drive the phenomenon. These findings contribute to the discourse on asset pricing in Pakistan, by integrating idiosyncratic volatility into the beta anomaly framework, proving returns are impacted by unsystematic risk. Future research should explore alternative risk factors such as leverage, liquidity, and momentum, and examine how idiosyncratic volatility interacts with market cycles to develop more effective investment strategies. Investors should adopt multi-factor asset pricing models to make informed investment decisions.

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