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Volatility forecasting, value- at- risk and expected shortfall estimations under the Basel II Accord in GCC shariah stocks

Chaker Aloui, M. Kabir Hassan and Hela Ben Hamida

The main purpose of this chapter is to assess risk for shariah-compliant stocks in the Gulf Cooperation Council (GCC) countries using the value-at-risk (VaR) and expected shortfall (ES) under Basel II Accord rules. Empirically, we conduct our forecasting analysis using the asymmetric power ARCH (APARCH) model under three return innovations’ distributions: normal, Student and skewed Student. Using daily data for Saudi Arabia, Kuwait, Oman and United Arab Emirates (July 2010–13), our results indicate that the APARCH model under skewed Student distribution out-performs the competing models and it sufficiently accounts for asymmetry and heavy tails in the shariah returns. Furthermore, this model provides more accurate VaRs and ES for both short and long positions. Finally, the APARCH model provides the lowest number of violations under the Basel II rules, given a risk exposure at the 99 per cent confidence level for all four shariah indexes. Our findings are useful for shariah market risks, Islamic hedge funds, policy regulations and for designing hedging strategies for shariah portfolios.
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Testing the financial distress prediction model for sukuk- issuing companies in Malaysia

Roslina Mohamad Shafi, Sharifah Raihan Syed Mohd Zain, Mohamed Eskandar Shah Mohd Rasid and Ahamed Kameel Mydin Meera

Companies are exposed to business and financial risk and are affected by business cycles and economic downturns. A company is fortunate if it is capable of preventing and alleviating financial crises by utilizing existing financial distress models to deal with volatile markets and changes in the global economy. Such models are capable of signalling to a company worst case scenarios and remedial possibilities to prevent future distress. However, applying such risk models to sukuk-issuing companies remains a point of contention because sukuk and related bonds are fundamentally different types of financial instruments and possess dissimilar risk exposure to traditional instruments. The current study examines this difference by testing existing financial distress prediction models on sukuk-issuing companies. The results show that the Altman and Ohlson financial distress models were capable of alerting companies of possible financial distress with a 52.78 per cent prediction accuracy. Further testing revealed that the Ohlson model produced a higher prediction power than the Altman model for Malaysian sukuk-issuing companies. These signify that logit model is more powerful for sukuk issuing companies.
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Taking a leap of faith: are investors left short changed?

Yunieta A. Nainggolan, Janice C.Y. How and Peter Verhoeven

This chapter examines the compliance and performance of an international sample of faith-based ethical funds which screen their investment not only on risk and return but also on compliance with Islamic law – Islamic equity funds (IEFs). Using a set of stringent shariah screens similar to those of Morgan Stanley Capital International (MSCI) Islamic Index, we find less than one-third of the equity holdings of IEFs are shariah compliant. While most of the fund holdings pass the business screens, only about 38 per cent pass the total debt to total assets ratio screen. This finding suggests that, in order to overcome a significant reduction in the investment opportunity, shariah principles are compromised, with IEFs adopting lax screening rules in an attempt to achieve financial performance. Our matched firm approach shows that shariah screening reduces investment performance by an average of 0.04 per cent per month if benchmarked against matched conventional funds – this is a relatively small price to pay for religious faith. Cross-sectional regressions show an inverse relationship between shariah compliance and fund performance: every 1 percentage point increase in total compliance decreases fund performance by 0.01 per cent per month. However, shariah compliance fails to explain relative performance of the funds when matched with conventional funds.
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Social tax and transfers for poverty alleviation: a case for low- and middle- income countries

Nasim Shah Shirazi and Muhammad Anas Zarka

The world has made notable progress in achieving the Millennium Development Goal (MDG) of halving the rate of extreme poverty (from 43 per cent in 1990 to about 17 per cent in 2011) before 2015. Nevertheless, about 1 billion people are still under the poverty line. Despite the progress at the global level, poverty prevails with different intensity in different parts of the world. Abject poverty and extreme deprivation are still present and any programme to reduce them requires a transfer of resources from the rich to the poor. Sustaining such transfers requires viewing them as a moral imperative on the rich, as emphasized by most religions. This chapter rekindles such view and highlights its practical potential based on Islamic rules about zakat, which are a culmination of earlier Divinely inspired teachings.
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Social preferences and values: an experimental analysis for religiosity

Anwar Shah, Karim Khan and Hayat Khan

The mainstream economic theory assumes that individuals’ preferences are exogenous and self-regarding. However, the laboratory experiments show that in most of the cases, individuals’ preferences exhibit regard for others. It is widely believed that values and norms can foster the other-regarding behaviour by constraining selfishness. This does not imply that selfish behaviour is dead as there is enough experimental evidence that other-regarding individuals use information asymmetry for their personal gains. In this study, while controlling for one aspect of values, that is, religion, we investigate whether individuals behave significantly differently when we control for their religiosity. We examine the behaviours of proposers in a modified ultimatum game after priming their religious identity. Using hadith, saying of the Holy Prophet Muhammad Peace Be Upon Him (PBUH), as a priming instrument, we find that most of the proposers make equitable offers to the responders as compared to the controlled treatment. This is in spite of the fact that the proposers could use information asymmetry regarding the size of the pie for maximizing their private gains. The study suggests that promoting universal values can be beneficial for the promotion of pro-social or other-regarding behaviour.
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The social and cultural impact on firms’ access to finance in an Islamic environment

Charilaos Mertzanis

In this chapter, the focus is on the extent to which firms in a sample of Islamic countries face obstacles to accessing finance. Specifically, the chapter provides an account of the determinants of firms’ access to finance in the sample of Islamic countries. A set of firm-level survey data, based on private sector firm responses, is used to analyse the impact of firm-level and country-specific factors on the extent to which firms in the sample of Islamic countries face constraints to finance. Further, the analysis introduces country-level factors and examines the impact of those factors at different levels of economic, financial, institutional and human development of the sample countries. The results suggest that certain firm characteristics, such as age, size and foreign ownership, predict financing constraints, while others, such as sectoral activity (that is, manufacturing), external audit of accounts, government ownership and internal funds-based investment have predictive power that varies along different institutional conditions and in accordance with the model specification.
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Reporting of zakat and charitable activities in Islamic banks: theory and practice in a multi- cultural setting

Mamunur Rashid, M. Kabir Hassan, How Shi Min and G.M. Wali Ullah

This study aims at understanding the theory and practice of the reporting of zakat and charitable activities in Islamic banks in selected countries, an average size of the zakat amount, and how the reporting of zakat and charitable activities stands against other ethical identity indicators. Existing theories of corporate social responsibility (CSR) reporting and International Financial Reporting Standards (IFRS) in the selected countries are discussed. The selected banks are a mixture of purely Islamic banks and banks offering dual banking services. The countries are Bangladesh and Malaysia. To understand the practices of zakat and charitable reporting, the study employs Weber’s appearance-based content analysis where a score of ‘1’ was assigned for the presence and ‘0’ for the absence of any zakat and charity activity. An average was calculated for each activity, year and country. zakat reporting is further divided into pre- and post-crisis periods where the year 2008 was considered as the cut-off year (2009 onward was the post-crisis period). The zakat and charitable activity reporting indices were analysed against other ethical identity indicators for the same pre- and post-crisis periods. The amount of zakat as a percentage of total asset and as a percentage of net profit after tax for the post-crisis period was determined in order to gain an understanding of the charitable contribution by Islamic banks.
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Quantitative studies of Islamic and conventional assets

Shumi Akhtar and Maria Jahromi

This chapter introduces three quantitative studies of Islamic and conventional stock and bond assets. These studies explore performance characteristics in addition to the impact of financial crises and macroeconomic news surprises. As of 2013, global Islamic financial assets were $1.7 trillion and they are forecast to grow to $3.4 trillion by 2018. Islamic assets have been growing at a substantial average annual rate of 17.6 per cent over the period 2008–12, increasing 50 per cent faster than the overall banking sector. In this context, this chapter is well positioned to contribute to the emerging body of quantitative research on Islamic financial products. The results of these studies will provide key information for local and international investors setting investment and portfolio management strategies involving Islamic assets.
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Profit- sharing ratio as a screening device in venture capital

Meryem Mehri, Kaouther Jouaber- Snoussi and M. Kabir Hassan

Both Islamic and conventional venture contracts suffer from information asymmetry and incentive problems. The venture capitalist and the manager have an agency relationship because of the insufficient information about the financed investment and/or the manager type. This chapter presents a literature review of agency problems in venture contracts and proposes a theory of profit sharing ratio (PSR) with information asymmetry about the manager type. In order to avoid the adverse selection, the negotiated PSR acts as a screening device in this theoretical framework. We show that adverse selection is signalled when the manager accepts a PSR set beyond a given critical value. This threshold of the PSR corresponds to the maximum payoff to the venture capitalist. Likewise, the negotiation of the PSR offers a new tool for the screening managers’ type. We suggest that the PSR level may complete the carried interest in conventional venture contracts.
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Poverty, finance and institutions: evidence from OIC countries

Muhammad Tariq Majeed

This chapter investigates poverty effects of finance and institutions using panel data for Organization of Islamic Conference (OIC) developing countries from 1984 to 2012. The results show that economic growth helps reduce poverty. The role of institutions for the poor of the Muslim world turns out to be more conducive than economic growth. In all of the cross-sectional and panel regressions, the index for institutions remains consistently negative and significant. The role of finance is also important, but it is not robust as it depends on the proxy of financial development. The monetization effect is stronger than the credit effect. The strong hold of law and order and stable governments are the important dimensions of institutional framework which help the poor, while corruption turns out to be one of the major causes of poverty in OIC countries. This study concludes that institutions are the basic prerequisite for helping the poor in OIC countries.