How Stock Prices Behave in Response to Institutional Development: A Four‐Factor Asset Pricing Model

ABSTRACT This study empirically explains the stochastic behaviour of stock returns from January 2004 to December 2018 in Pakistan. Carhart's Four‐Factor Asset Pricing model is analysed using the time‐varying risk premium GARCH‐in‐Mean framework technique to establish the risk–return relationship in the Pakistan Stock Exchange. The results indicate that the effects of beta, size, value and momentum effect‐based portfolios significantly highlight a relation between risk and return. The predicted return volatility across all sorts of portfolios is rather considerable. The nonsynchronous trading effect and persistent return volatility are both visible in the Pakistan Stock Exchange. The study also distinguishes the stock price behaviours after financial liberalisation in 2009.