Does ESG matter? Investigating the ESG Premium in the Pakistan Stock Market. An Asset Pricing Approach

Kalsoom Shema; Summaya  Chughtai

doi:10.62270/jirms.v6i3.107

Authors

Kalsoom Shema MS Scholar, Faculty of Management Sciences, International Islamic University (IIU), Islamabad, Pakistan. https://orcid.org/0009-0001-1580-5616
Summaya Chughtai Assistant Professor, Faculty of Management Sciences, International Islamic University (IIU), Islamabad, Pakistan https://orcid.org/0000-0002-2394-9767

DOI:

https://doi.org/10.62270/jirms.v6i3.107

Keywords:

Assets pricing model, Pakistan Stock Exchange, ESG- based six-Factor model, ESG premium

Abstract

Purpose—The Fama and French (2015) five-factor model has been extended by adding ESG premium (ESG-based high minus low return spread) as an additional risk factor to examine its impact on excess returns of portfolios in the emerging market of Pakistan.

Study Design/methodology/approach—Monthly stock prices data of 70 non-financial firms have been gathered from June 2015 to July 2023 to construct portfolios. 32 portfolios are created based on size, value, profitability, investment, and ESG premium. Fama & French (1993, 2015) OLS time series regression is run to check the applicability of the model.

Findings—The equities that are traded on the PSX have premiums for MKT, SMB, HML, RMW, CMA, and HML_ESG factors. Higher R² values of the six-factor model indicate its efficiency in capturing stock return variations. MKT remains the biggest component across all models. SMB regularly has positive coefficients, indicating that small-cap firms beat large-cap equities. RMW and CMA yield inconsistent results, suggesting that profitability and investment factors are dependent on the portfolio. Furthermore, the presence of CMA and RMW factors does not negate the value component.

Practical Implications—The better performance of the HML_ESG-based six-factor model emphasizes the significance of ESG-related factors in stock valuation. ESG should be considered as a priced risk factor, enabling investors and asset managers to incorporate it into asset pricing to better capture hidden sustainability risk and improve long-term portfolio performance.

Originality/value—First, this study adds to the current asset pricing models by suggesting an ESG-based six-factor model. Second, this paper highlights the importance of the factor model and provides valuable insight for investors. Third, this study is the first to extend the Fama and French (2015) model by adding an ESG-based risk factor to assess its impact in the Pakistani market.