When Market Misbehaves: An Irrational Version of the Asset Pricing Model in the Emerging Market of Pakistan
DOI:
https://doi.org/10.62270/jirms.v6i3.132Keywords:
Behavioral-CAPM, Capital Asset Pricing Model (CAPM), Emerging Markets, Herding, Investor Psychology, Overconfidence, Over-reaction, Pakistan Stock Exchange (PSX), Sentiment, Under-reactionAbstract
The traditional asset pricing model assumes investors’ rationality, yet the emerging markets misbehave, and our most fundamental pricing models simply fail to defend their myth.
Purpose—This study aims to develop the Behaviorally Extended Capital Asset Pricing Model (BECAPM), an irrational version of the CAPM by incorporating six behavioral variables in the traditional single-factor model to check predictability improvement of returns in the context of emerging capital markets like the Pakistan stock exchange.
Study Design/methodology/approach—Accumulating the daily data of 100 listed companies of the KSE-100 Index from 2005 to 2024 from PSX official website, SBP data center, and investing.com, behavioral variables have been constructed using price dispersions, cumulative abnormal returns, Cross-Sectional Absolute Deviation (CSAD), principal component, and dividend announcements as highlighted by the existing literature. Seven nested regression models with Newey-West robust standard errors were estimated and compared for prediction accuracy.
Findings—The fully extended BECAPM demonstrates a 48% improvement in explanatory power over single-factor CAPM. Though the primacy of systematic risk remains dominant, herding exhibits the strongest negative impact (β = -1.052), and dividend preference emerges as the most significant positive factor (β = 0.387). Model selection criteria unanimously support behavioral extensions. Structural break analysis reveals amplified behavioral effects during crisis periods (2008 financial crisis, 2020 pandemic).
Practical Implications—This study would be helpful to the portfolio managers in better decision making for investments, the regulators in devising a better monitoring system for speculative trading, and the academics to enhance financial literacy programs that target the reduction in cognitive bias to enhance market efficiency and snub mispricing.
Limitations—The construction of behavioral factors relies on market-based proxies rather than direct psychological measures. Analysis of single market limits generalization.
Originality/value—It is the first study in our knowledge to incorporate multiple psychological factors into a unified pricing model and provide empirical validation of behavioral risk factors simultaneously.
References
Abideen, Z. U., Ahmed, Z., Qiu, H., & Zhao, Y. (2023). settingsOrder Article Reprints Open AccessEditor’s ChoiceArticle Do Behavioral Biases Affect Investors’ Investment Decision Making? Evidence from the Pakistani Equity Market. DOI: https://doi.org/10.3390/risks11060109
Aljifri, R. (2023). Investor psychology in the stock market: An empirical study of the impact of overconfidence on firm valuation. Borsa Istanbul Review, 23(1), 93-112. DOI: https://doi.org/10.1016/j.bir.2022.09.010
Almansour, B. Y., Elkrghli, S., & Almansour, A. Y. (2023). Behavioral finance factors and investment decisions: A mediating role of risk perception. Cogent Economics & Finance, 11(2), 2239032. DOI: https://doi.org/10.1080/23322039.2023.2239032
Bajo, E., Cecchini, M., & Oliver, B. (2023). Psychological profile and investment decisions. Finance Research Letters, 58, 104245. DOI: https://doi.org/10.1016/j.frl.2023.104245
Baker, M., & Wurgler, J. (2006). Investor sentiment and the cross‐section of stock returns. The journal of finance, 61(4), 1645-1680. DOI: https://doi.org/10.1111/j.1540-6261.2006.00885.x
Baker, M., & Wurgler, J. (2007). Investor sentiment in the stock market. Journal of economic perspectives, 21(2), 129-151. DOI: https://doi.org/10.1257/jep.21.2.129
Banz, R. W. (1981). The relationship between return and market value of common stocks. Journal of Financial Economics, 9(1), 3-18. DOI: https://doi.org/10.1016/0304-405X(81)90018-0
Barberis, N., Shleifer, A., & Vishny, R. (1998). A model of investor sentiment. Journal of Financial Economics, 49(3), 307-343. DOI: https://doi.org/10.1016/S0304-405X(98)00027-0
Barberis, N., & Thaler, R. (2003). A survey of behavioral finance. Handbook of the Economics of Finance, 1, 1053-1128. DOI: https://doi.org/10.1016/S1574-0102(03)01027-6
Bernard, V. L., & Thomas, J. K. (1989). Post-earnings-announcement drift: delayed price response or risk premium? Journal of Accounting research, 27, 1-36. DOI: https://doi.org/10.2307/2491062
Bouteska, A., Harasheh, M., & Abedin, M. Z. (2023). Revisiting overconfidence in investment decision-making: Further evidence from the US market. Research in International Business and Finance, 66, 102028. DOI: https://doi.org/10.1016/j.ribaf.2023.102028
Chen, Y.-C., & Liu, Y.-S. (2023). Market efficiency and stock investment loss aversion guide during COVID-19 pandemic events: the case for applying data mining. Sage Open, 13(4), 21582440231215956. DOI: https://doi.org/10.1177/21582440231215956
Chiang, T. C., & Zheng, D. (2010). An empirical analysis of herd behavior in global stock markets. Journal of Banking & Finance, 34(8), 1911-1921. DOI: https://doi.org/10.1016/j.jbankfin.2009.12.014
Christie, W. G., & Huang, R. D. (1995). Following the pied piper: do individual returns herd around the market? Financial Analysts Journal, 51(4), 31-37. DOI: https://doi.org/10.2469/faj.v51.n4.1918
Daniel, K., Hirshleifer, D., & Subrahmanyam, A. (1998). Investor psychology and security market under‐and overreactions. The journal of finance, 53(6), 1839-1885. DOI: https://doi.org/10.1111/0022-1082.00077
De Bondt, W. F., & Thaler, R. (1985). Does the stock market overreact? The journal of finance, 40(3), 793-805. DOI: https://doi.org/10.1111/j.1540-6261.1985.tb05004.x
Desmettre, S., Grün, S., & Korn, R. (2018). Portfolio optimization with early announced discrete dividends. Operations Research Letters, 46(5), 548-552. DOI: https://doi.org/10.1016/j.orl.2018.09.001
Dirir, S. A. (2022). An examination of behavioral biases that affect investors’ decisionmaking:(A case study of Pakistanis investors). Journal of school of management and economics, 5(2), 456-468.
Fama, E. F. (1970). Efficient capital markets: A review of theory and empirical work. The journal of finance, 25(2), 383-417. DOI: https://doi.org/10.1111/j.1540-6261.1970.tb00518.x
Fama, E. F., & French, K. R. (1993). Common risk factors in the returns on stocks and bonds. Journal of Financial Economics, 33(1), 3-56. DOI: https://doi.org/10.1016/0304-405X(93)90023-5
Fama, E. F., & French, K. R. (1995). Size and book‐to‐market factors in earnings and returns. The journal of finance, 50(1), 131-155. DOI: https://doi.org/10.1111/j.1540-6261.1995.tb05169.x
Fama, E. F., & French, K. R. (2015). A five-factor asset pricing model. Journal of Financial Economics, 116(1), 1-22. DOI: https://doi.org/10.1016/j.jfineco.2014.10.010
Fama, E. F., & French, K. R. (2018). Choosing factors. Journal of Financial Economics, 128(2), 234-252. https://doi.org/https://doi.org/10.1016/j.jfineco.2018.02.012 DOI: https://doi.org/10.1016/j.jfineco.2018.02.012
FU, Z. (2025). CAPM INSIGHTS: APPLE'S RISK AND EXPECTED RETURNS. ADVANCES IN ECONOMICS, MANAGEMENT AND POLITICAL SCIENCES Учредители: Eliwise Academy Ltd, 151(1), 46-51. DOI: https://doi.org/10.54254/2754-1169/2024.19325
Gokhale, G. M., & Mittal, A. (2024). Exploring the nexus of capital market and investor behaviour: A systematic literature review. International Journal of Economics and Financial Issues, 14(2), 65. DOI: https://doi.org/10.32479/ijefi.15638
Guo, P., Li, S., & Wang, Y. (2023). Asset pricing with dividend surprises. Finance Research Letters, 58, 104353. DOI: https://doi.org/10.1016/j.frl.2023.104353
Hassan, M. T. U., & Jamil, S. H. (2021). investigative study of investor’s herding behavior during bullish and bearish market: A case of Pakistan Stock Exchange. European Journal of Business and Management Research, 6(3), 17-25. DOI: https://doi.org/10.24018/ejbmr.2021.6.3.847
Hens, T., & Naebi, F. (2022). Behavioral heterogeneity in the CAPM with evolutionary dynamics. Journal of Evolutionary Economics, 32(5), 1499-1521. DOI: https://doi.org/10.1007/s00191-022-00786-3
Hirshleifer, D. (2020). Behavioral biases of analysts and investors. NBER Reporter(2), 6-9.
Hong, H., & Stein, J. C. (1999). A unified theory of underreaction, momentum trading, and overreaction in asset markets. The journal of finance, 54(6), 2143-2184. DOI: https://doi.org/10.1111/0022-1082.00184
Hou, K., Xue, C., & Zhang, L. (2015). Digesting anomalies: An investment approach. The review of financial studies, 28(3), 650-705. DOI: https://doi.org/10.1093/rfs/hhu068
Jabeen, S., Farhan, M., & Rizavi, S. S. (2023). An Investigation of Herding Prospects in the Pakistan Stock Exchange. International Journal of Business and Economic Affairs, 8(1), 26-40. DOI: https://doi.org/10.24088/IJBEA-2023-81003
Jegadeesh, N., & Titman, S. (1993). Returns to buying winners and selling losers: Implications for stock market efficiency. The journal of finance, 48(1), 65-91. DOI: https://doi.org/10.1111/j.1540-6261.1993.tb04702.x
Kahneman, D., & Tversky, A. (1984). Choices, values, and frames. American psychologist, 39(4), 341. DOI: https://doi.org/10.1037/0003-066X.39.4.341
Kahneman, D., & Tversky, A. (2013). Prospect theory: An analysis of decision under risk. In Handbook of the fundamentals of financial decision making: Part I (pp. 99-127). World Scientific. DOI: https://doi.org/10.1142/9789814417358_0006
Khan, M. N. (2024). Market volatility and crisis dynamics: a comprehensive analysis of US, China, India, and Pakistan stock markets with oil and gold interconnections during COVID-19 and Russia–Ukraine war periods. Future Business Journal, 10(1), 22. DOI: https://doi.org/10.1186/s43093-024-00314-8
Kim, J. B., Luo, L., & Xie, H. (2024). Do dividends mitigate bad news hoarding, overinvestments, and stock price crash risk? Accounting & Finance, 64(4), 3999-4038. DOI: https://doi.org/10.1111/acfi.13297
KORPES, A. D. A. (2023). The Impact of Dividend Policy on Company Financial Performance During the Covid 19 Pandemic : An Empirical Analysis. European Journal of Business and Management, 15(6), 90-95. https://doi.org/10.7176/EJBM/15-6-09 DOI: https://doi.org/10.7176/EJBM/15-6-09
Kumar, K. (2022). Investor Overreaction in Microcap Earnings Announcements. International Journal of Humanities and Information Technology, 4(01-03), 11-30. DOI: https://doi.org/10.21590/ijhit.04.01-3.03
Lintner, J. (1975). The valuation of risk assets and the selection of risky investments in stock portfolios and capital budgets. In Stochastic optimization models in finance (pp. 131-155). Elsevier.
Markowitz, H. (1952). Portfolio Selection. journal oI Finance. DOI: https://doi.org/10.2307/2975974
Miller, M. H., & Modigliani, F. (1961). Dividend policy, growth, and the valuation of shares. the Journal of Business, 34(4), 411-433. DOI: https://doi.org/10.1086/294442
Nababan, B. C., Sadalia, I., Prasetya, M. D., & Adelia, N. (2025). Dividend Policy And Stock Price: Testing The Miller-Modigliani Dividen Irrelevant Theory LQ45 In Indonesia. SOUTHEAST ASIA JOURNAL oF GRADUATE OF ISLAMIC BUSINESS AND ECONOMICS, 3(3), 150-156. DOI: https://doi.org/10.37567/sajgibe.v3i3.3399
Nguyen, J., & Parsons, R. (2022). A study of market efficiency in emerging markets using improved statistical techniques. Emerging Markets Finance and Trade, 58(7), 2004-2016. DOI: https://doi.org/10.1080/1540496X.2021.1949981
Nguyen, T. A. N., & Nguyen, C.-V. (2025). Factors affecting corporate financial performance listed on Vietnam stock market. Cogent Business & Management, 12(1), 2464937. DOI: https://doi.org/10.1080/23311975.2025.2464937
Odean, T. (1998). Are investors reluctant to realize their losses? The journal of finance, 53(5), 1775-1798. DOI: https://doi.org/10.1111/0022-1082.00072
Perveen, A., Mahmood, F., & Riaz, A. (2024). Herd Investing in Pakistani Stock Market: Evidence from Pakistan’s Stock Market Using Data of More Than Three Decades. Journal of Development and Social Sciences, 5(2), 211-221. DOI: https://doi.org/10.47205/jdss.2024(5-II)21
Rahman, S., Kazmi, S. A. R., & Ramzan, M. (2022). Investors sentiment and stock return; Evidence from Pakistan stock exchange (PSX). International Journal of Business and Economic Affairs, 7(2), 65-74. DOI: https://doi.org/10.24088/IJBEA-2022-72006
Raza, H., Ramakrishnan, S., Gillani, S., & Ahmad, H. (2018). The effect of dividend policy on share price: A conceptual review. International Journal of Engineering & Technology, 7(4.28), 34-39. DOI: https://doi.org/10.14419/ijet.v7i4.28.22386
Shefrin, H., & Statman, M. (2000). Behavioral portfolio theory. Journal of financial and Quantitative Analysis, 35(2), 127-151. DOI: https://doi.org/10.2307/2676187
Shefrin, H. M., & Statman, M. (1984). Explaining investor preference for cash dividends. Journal of Financial Economics, 13(2), 253-282. DOI: https://doi.org/10.1016/0304-405X(84)90025-4
Tversky, A., & Kahneman, D. (1992). Advances in prospect theory: Cumulative representation of uncertainty. Journal of Risk and uncertainty, 5(4), 297-323. DOI: https://doi.org/10.1007/BF00122574
ul Abdin, S. Z., Farooq, O., Sultana, N., & Farooq, M. (2017). The impact of heuristics on investment decision and performance: Exploring multiple mediation mechanisms. Research in International Business and Finance, 42, 674-688. DOI: https://doi.org/10.1016/j.ribaf.2017.07.010
Wang, X., Zhu, Y., & Tang, P. (2024). Uncertain mean-CVaR model for portfolio selection with transaction cost and investors’ preferences. The north american journal of economics and finance, 69, 102028. DOI: https://doi.org/10.1016/j.najef.2023.102028
Yoo, J., & Ahn, S. J. (2025). Dividend Yields and Stock Returns. Asian Review of Financial Research, 38(3), 37-76. DOI: https://doi.org/10.37197/ARFR.2025.38.3.2
Yuan, R. F. S. Y. (2015). Mispricing Factors. NBER: National Bureau of Economic Research. http://www.nber.org/papers/w21533
Zaiane, S. (2013). Overconfidence, trading volume and the disposition effect: Evidence from the Shenzhen Stock Market of China. Journal Issues ISSN, 2350, 157X.
Zhang, C. (2025). Dynamic Asset Pricing: Integrating FinBERT-Based Sentiment Quantification with the Fama--French Five-Factor Model. arXiv preprint arXiv:2505.01432.
Zia Ur Rehman, M., ul Abidin, Z., Rizwan, F., Abbas, Z., & Baig, S. A. (2017). How investor sentiments spillover from developed countries to developing countries? Cogent Economics & Finance, 5(1), 1309096. DOI: https://doi.org/10.1080/23322039.2017.1309096
Downloads
Published
Data Availability Statement
Data can be provided upon request to the corresponding author.
Issue
Section
License
Copyright (c) 2025 Zain-ul- Abidin, Muhammad Zia-ur-Rehman, Khalid LAtif
This work is licensed under a Creative Commons Attribution 4.0 International License.
Authors retain copyright and grant the journal right of first publication with the work simultaneously licensed under a Creative Commons Attribution (CC-BY) 4.0 License that allows others to share the work with an acknowledgment of the work’s authorship and initial publication in this journal.
How to Cite
