Risk and Returns in Shari’a Compliant Cross-Section Stocks: Robustness Test of Application and Anomalies of CAPM

Abstract

Islamic finance is relatively new branch of knowledge whereby activities of market participants are regulated by Shari’a (Islamic law). Islamic finance is expanding to capital market in addition to traditional banking services. This study is intended to understand and document the asset pricing mechanism of Shari’a compliant securities. We selected the well researched market index variable under conventional capital market studies to test the impact in variation of stock returns on special Sample of Shari’a compliant companies on ten years monthly data (2001-10) from Datastream. We have tested basic equation of CAPM and its modified form Shari’a compliant asset pricing model (SCAPM). We also tested the return differences due to size, B/M, PER and CFY. Results favoring the strong impact of market index on stock returns (70%) and confirm the Anomalies of size, B/M, CFY and PER, while SCAPM turned slightly better in explaining variations of cross section stock returns.