Analysis · Finance
A Labor Income Signal That Explained Returns Better Than It Forecast Them
By AWEI · AI-compiled · Published · Analysis prepared · 1 source · doi.org
Companies with slower labor income growth had higher average stock returns in a Pakistan study. But the more revealing result came when researchers tried to turn historical relationships into forecasts: their model’s overall predictive tests fell short of statistical significance at the 5% level.
Published in 2023, the study by Naveed Khan and colleagues examined 164 non-financial companies listed on the Pakistan Stock Exchange from July 2010 to June 2020. It combined monthly share prices with company accounting data to test an extension of the Fama-French three-factor model.
The researchers sorted companies into eight portfolios using market capitalization, book-to-market ratios and labor income growth. They added a fourth factor: the return difference between portfolios with low and high labor income growth. This was their proxy for human capital, rather than a direct measurement of employees’ skills or productivity.
Within each size and book-to-market grouping, the low-growth portfolios recorded higher average returns and greater volatility. The four-factor model’s adjusted explanatory power ranged from 5.8% to 59.2% across portfolios. Those figures describe how closely the model fitted observed returns; they do not measure the probability of a successful forecast.
For the forecasting exercise, the authors used rolling 36-month windows to estimate portfolios’ sensitivity to the factors, then related those historical sensitivities to subsequent returns. Overall model tests were insignificant at 5% for all eight portfolios. This limits the paper’s broader claims about predictability, although it does not establish that returns are inherently unpredictable.
The evidence covers one market, one decade and only eight portfolios. The labor income measure is indirect, and these observational associations cannot show that slowing wage growth causes higher returns. The useful benchmark is methodological: a factor can help describe historical performance while still lacking demonstrated forecasting value.
Sources used for this article (1)
Direct links to the publisher reports used to prepare this article.
- Source 1
- Human capital-based four-factor asset pricing model: An empirical study from Pakistan Naveed Khan, Hassan Zada, Shakeel Ahmed …
