Sukuk and Bond Puzzle: An Analysis with Characteristics Matched Portfolios

ABSTRACT

A sukuk is an Islamic financial asset structured to offer investors a cash flow equivalent to that of a bond. The difference between them is in their contractual mechanism: a bond constitutes a lender–borrower relationship between the holders and issuers whereas a sukuk constitutes a lessor-lessee, buyer-seller, or a partnership relationship. Therefore, we examine whether they are different assets in terms of their return and risk profile. Given the difference between them, it is also important to identify what drives sukuk returns. The study finds that sukuk returns are insignificantly different from those of bonds but have significantly higher risk. However, we find that sukuk investors are not sufficiently compensated for the higher risk. Overall, our study finds that sukuks’ market performance is unrelated to bond market performance, but the market performance of the industry in which the sukuk-financed project originates has a significant effect on sukuk performance.

KEYWORDS:

• Conventional bond
• industry performance
• sukuk
• sukuk performance

JEL:

• G10
• G12

Acknowledgments

We acknowledge the financial assistance and research supports received from Taylor’s University. We are grateful to Obiyathulla Ismath Bacha, Subramaniam Pillay, Nazrol Kamil, Vinitha Guptan, and Sabur Mollah for providing critical comments. The earlier version of this paper won the best paper award at the International Conference on Applied Economics and Policy (ICAEP) 2017, University of Malaya, Malaysia, August 21–22 2017. We are thankful to the reviewers who spent their valuable time to read our paper thoroughly and suggest changes.

Supplementary material

Supplemental data for this article can be accessed on the publisher’s website

Notes

1. We provide an analysis of sukuks contractual mechanism in Appendix S1 available online.

2. The ADRL estimation method is appropriate because the time-series variables are integrated at different levels, i.e., the performance of sukuks, industries, and bonds is integrated at the I(0) and I(1) levels, but equity performance is integrated only at I(0). We also confirm that none of these time-series are integrated at the I(2) level.