Systematic Risk in Conventional and Islamic Equity Markets

• Published date: 01 September 2016
• DOI: http://doi.org/10.1111/irfi.12077
• Date: 01 September 2016

Systematic Risk in Conventional and

Islamic Equity Markets

AHMET SENSOY

Research & Business Development, Borsa Istanbul, Istanbul, Turkey

ABSTRACT

We aim to compare the systematic risk in conventional and Islamic equity

markets by introducing two dynamic risk measures. Accordingly, the level of

the systematic risk in conventional markets is slightly higher than the risk in

Islamicmarkets for most of the time.However,this difference is significantin less

than 3% of the sample period. More importantly, there is no significant

difference in the levels of systematic risk during the global financial crisis of

2008, suggestingthat Islamic equities arenot able to provide a lower marketrisk

compared with theirconventional counterparts in financialturbulent times.

JEL classification: C14, C58, G01, G15,G32

In financial markets, systematic risk is the risk that may affect the functioning of

the entire market and cannot be avoided through measures such as portfolio di-

versification. Also known as the market risk, it affects the overall system, not just

a particular stock or industry.

Although the subject has been of interest for a long time in finance literature, it has

become more important than ever in the last decade due to the catastrophic events

triggered by the late global financial crisis. In particular, anyone who invested in the

equity markets in 2008 saw the values of their investments change (drop) because

of this market-wide economic event, regardless of what types of equities they held.

Within this crisisperiod, in an environment where eventhe benefits of portfolio

diversification have been questioned, market players and academics started to

search for remedies and renovation solutions to the problem of systematic risk in

conventional financial system. In this process, Islamic equity markets (i.e., Sharia

compliant stocks) emerged as a viable alternative because of their seemingly resil-

ient structure.

1

In particular, Sharia compliant stocks are low-leverage stocks with

1 Sharia compliance excludes companies whose primary businessesare alcohol, pork-relatedprod-

ucts, conventional financialservices, tobacco,entertainment (e.g., gambling, hotels,and pornog-

raphy) weapons and defense. In addition, it strictly imposes the zero interest-based leverage.

However, as the latter condition ishard to satisfy, a certain tolerance is required. Accordingly, to

be compliant with Shariarules, the following financial ratios must be lower than 33%: (i) total

debt dividedby trailing 24-monthaverage market capitalization, (ii) thesum of a company’scash

and interest-bearing securities divided by trailing 24-month average market capitalization, and

(iii) accountsreceivables divided by trailing24-month average market capitalization.

© 2016 International Review of Finance Ltd. 2016

International Review of Finance, 16:3, 2016: pp. 457–466

DOI: 10.1111/irfi.12077