Human Capital Based Six-Factor Asset Pricing Model in the Era of Covid-19

Abstract

In recent years, the COVID-19 pandemic has heightened trade tensions and geopolitical risks, affecting stock market volatility and the factors that determine the pricing of financial securities. This study examines the role of human capital in the Fama-French (2015) five-factor model to explain excess portfolio returns. For this purpose, we collected daily stock prices data for 73 non-financial firms listed on the Pakistan Stock Exchange from July 2018 to June 2023. For estimation, we employed two models: first, the Fama-French time-series regression, second, the Fama–Macbeth (1973) rolling-window two-pass regression. We find that the six-factor model significantly explains time-series variations in excess portfolio returns. Notably, the human capital premium is significantly and negatively related to excess portfolio returns. However, a significant and positive coefficient for the COVID-19 dummy and a significant and negative coefficient for the interaction between human capital and COVID-19 across several portfolios indicate that, on average, during COVID-19, excess portfolio returns have improved. In contrast, increased expenditures on human capital are negatively related to excess portfolio returns. The results have meaningful implications for investors, portfolio managers, and policymakers. It is suggested that the human capital factor be incorporated into asset pricing. Further, it emphasizes developing strategies to maintain investor confidence during crises like the COVID-19 pandemic.