Investor Behavior: Does Tax Avoidance and Liquidity Preference Culture Drive Equity Prices in Pakistan

Abstract

Research on investor behavior in Pakistan shows mixed results. One of the main reasons is that most emerging countries are plagued by market distortions and pricing incongruities. In Pakistan, studies have examined different asset pricing models without observing any acceptable explanations for anomalies. This study tries to fill this gap by studying investor behavior in Pakistan. The data sample is taken from the PSX (Pakistan Stock Exchange) 100 Index and we constructed eighteen portfolios to empirically analyze investor behavior evidenced through surplus returns of these portfolios in this market. The findings indicate that investor behavior digresses from that observed by Fama and French ( 2015 ), and we do not observe strong support for their contentions. In our study F&F 5 model explains the distribution of average excess returns only within selective portfolios; small weak - profitability stocks, big neutral - profitability stocks, and big conservative - investment stocks. While risk and size factors drive asset prices, value and profitability premium are less important. This could stem from a tax evasion culture and the need to avoid tax payments in emerging countries. The preference for liquidity and strong cash flow - investment sensitivity is apparent in the importance of the investment premium factor. Here larger investments would indicate cash-rich companies and influence investor decisions alike. The weak results of portfolio intercepts suggest there could be some omitted variables not considered in the F&F 5 model. Therefore, we recommend that in emerging countries, asset pricing models need to incorporate aspects of investor behavior and culture to realistically capture market dynamics. It would enable more accurate forecasting, reduce investor asymmetry, and mispricing by creditors and capital markets. This is one of the few studies to examine and explain investor behavior within the context of its own specific culture and environment. The study attempts to explain the anomalies through investor behavior characteristics, and is the first to suggest that tax avoidance culture and cash preferences may drive investor preferences and equity prices in these markets. It highlights the importance of investment considerations, and the lower importance of value and profitability in these equity markets stemming from cultural and behavioral perspectives.