This study evaluates the ability of the Fama and French Three
Factor model to explain a cross section of stock returns in the Karachi
Stock Exchange (KSE). Following Fama and French factor approach, we
sorted six portfolios by size and book to market. The sorted portfolios were
constituted to represent stocks from each and every sector of KSE. Using
Daily returns from January 2003 to December 2007, the excess returns for
each portfolio were regressed on market, size and value factors. Our
findings, in general, supported the notion of the three factor model. The
three factor model was able to explain the variations in returns for most of
the portfolios and the results remain robust when the sample was reduced
to control for the size effect. Our findings are consistent with most of the
studies that suggested the validity of the three factor model in emerging
markets. These results warrant for the inclusion of size and value factors
for valuation, capital budgeting and project appraisals, thus, having
substantial implications for fund managers, analysts and investors.