Why do sukuks (Islamic bonds) need a different pricing model?

Md Hamid Uddin, Sarkar H. Kabir, Mohammad Kabir Hassan, Mohammed S. Hossain, Jia Liu

Research output: Contribution to journalArticlepeer-review

Abstract

The global interest in sukuk, an Islamic alternative to bond financing, has grown rapidly, particularly after the 2008 global financial crisis, due to its distinctive features and investment quality. Sukuk were first launched in Malaysia and are presently available in 29 countries, including the United Kingdom, United States, Singapore, Hong Kong, and Luxembourg. Despite the global market prevalence of sukuk, asset pricing literature has not yet addressed the pricing mechanism of sukuk, which is inherently different from bonds and equity due to the contractual differences. However, analysts use LIBOR, or the Islamic interbank benchmark rate (IIBR), as the ad-hoc benchmark to evaluate sukuk performance. In this study, we develop a basic pricing model that captures the common risks in sukuk returns. We identify two risk factors for sukuk that require risk premiums: (i) sukuk market risk and (ii) information asymmetry risk. Using these two common sukuk risks factors, investment analysts can estimate the fair value of sukuk more precisely than other ad hoc measures available.
Original languageEnglish
JournalInternational Journal of Finance and Economics
Early online date17 Sep 2020
DOIs
Publication statusEarly online - 17 Sep 2020

Keywords

  • Sukuk pricing
  • Reference rate
  • Systematic risk factors
  • Two factor model

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