Open Access

ARTICLE

HUMAN CAPITAL AS A MISSING RISK DIMENSION IN MULTIFACTOR ASSET PRICING: EVIDENCE, THEORY, AND METHODOLOGICAL EXTENSIONS FROM EMERGING MARKETS

Issue Vol. 2 No. 2 (2025): Volume 2 Issue 2 --- Section Articles

Abstract

Asset pricing theory has undergone a profound evolution over the past several decades, transitioning from the elegant simplicity of single-factor models toward increasingly sophisticated multifactor frameworks designed to capture the complex realities of financial markets. The Capital Asset Pricing Model established the foundational intuition that systematic market risk should command a premium, yet persistent empirical anomalies soon challenged its explanatory power. Subsequent developments, most notably the Fama and French three-factor, five-factor, and related extensions, substantially improved empirical fit by incorporating size, value, profitability, and investment factors. Despite these advances, a growing body of scholarship has argued that even modern multifactor models remain incomplete, particularly in their treatment of labor income, skills, and human capital accumulation. This article provides a comprehensive theoretical, methodological, and interpretive examination of human capital as a missing risk dimension in asset pricing, with particular emphasis on emerging market contexts.

Building on the expanding literature that integrates labor income and human capital considerations into financial economics, the study critically engages with the human capital-based four-factor asset pricing model proposed and empirically tested in a developing market setting by Khan et al. (2023). That contribution represents a significant step toward reconciling asset pricing theory with the economic reality that human capital constitutes a dominant share of aggregate wealth, especially in economies characterized by demographic growth, labor-intensive production structures, and imperfect capital markets. By embedding human capital into a factor-based framework, recent research challenges the long-standing separation between labor economics and finance, offering a more holistic view of risk, return, and portfolio behavior.

The present article synthesizes classical asset pricing theory, the empirical evolution of multifactor models, and the conceptual foundations of human capital to articulate a unified analytical framework. It provides an extensive methodological discussion of factor construction, model estimation, and interpretive strategies suitable for contexts where data limitations, market frictions, and institutional heterogeneity are pronounced. Rather than relying on mathematical formalism or visual representations, the analysis develops its arguments through detailed descriptive reasoning grounded in the existing literature. The results section interprets empirical patterns documented in prior studies, emphasizing how the inclusion of human capital factors alters inference about traditional risk premia.

The discussion section offers an in-depth theoretical interpretation of these findings, situating them within broader debates on market efficiency, anomaly persistence, and the role of non-traded risks. Particular attention is given to the implications for emerging markets, where labor income risk, informal employment, and human capital volatility may exert a stronger influence on asset returns than in advanced economies. The article concludes by outlining limitations and proposing future research directions, including cross-country comparative designs, institutional refinements, and deeper integration of human capital dynamics into asset pricing theory. Through its extensive elaboration and critical synthesis, the study aims to contribute a publication-ready, theoretically rich perspective on the next stage of multifactor asset pricing research.

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