Islamic Indexes. Khaled Hussein Islamic Development Bank, Islamic Research and Training Institute, P.O. Box 9201, Jeddah 21432, Saudi Arabia Email: [email protected] I. Introduction. Over the past decade, the world of finance paid more attention to the area of "ethical" investment.
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A stock's weight is based on the outstanding number of shares and the price per share (S&P 500)
A stock's weight is determined by its price only
The concern with such an index is that a stock with small market capitalization but a high price can have large impact on the overall index return
Each stock has the same weight in the index
(Rit– Rft) = α + β (Rmt– Rft) + ε
Rit is the return on index i in month t,
Rft is the risk-free rate,
Rmt is the return on the benchmark portfolio in month t,
ε is an error term,
β is the index's systematic risk, i.e., its sensitivity to the return of the benchmark.
α is called Jensen's alpha,
Fama and French (1992, 1993) developed a multi-factor model,
suggesting that stock returns in excess of the risk-free rate are explained by the sensitivity of their return with respect to three factors:
and book to market equity
have explanatory power in explaining average returns if each variable is used alone.
( in business activities that are beneficial to the society Rit– Rft) = α + β (Rmt– Rft) +β1iSMBt + β2i
HMLt + ε
SMB The difference between the return on a portfolio of small capitalisation stocks and the return on a portfolio of a large capitalisation stocks;
HML The difference between the return on a portfolio of high book-to-market stocks and the return on a portfolio of low book-to-market stocks.
Due to increased monitoring costs, availability of a smaller investment universe,
and restricted potential for diversification,
it has been argued that unscreened benchmarks should outperform Islamic (ethical) investment.
its 13 sub-indices (based on size and industry), and their DJ counterparts.
Data were obtained from the Dow Jones company database for the time period December 1995 and July 2003.
The papers leave us with a paradox: The positive abnormal returns of Islamic indices in the bull market period, then negative abnormal performance in the subsequent period (bear period).
Are the abnormal negative returns of Islamic indices attributed to market inefficiency, where these indices experience huge gains in the bull market and then underperform their index counterparts in the downturn period?
What is the exact role of leverage ratio in determining firm performance under different market conditions?
And do the prevailing interest rates in the market matter? More investigation is needed to cover these issues, among others, to be able to provide additional evidence regarding some of the patterns of Islamic indices’ behavior, and before the results of this paper can be interpreted conclusively.