Cross section of stock returns on Shari’ah-compliant stocks: evidence from Pakistan

Abstract

Purpose

This paper aims to study the cross section of expected returns on Shari’ah-compliant stocks in Pakistan by using single- and multi-factor asset pricing models.

Design/methodology/approach

To estimate cross section of expected returns of Shari’ah-compliant stocks, the study uses capital asset pricing model (CAPM), Fama-French three-factor model and Fama-French five-factor model. Data for the period 2001-2015 on 217 companies are used. For the market portfolio, PSX-100 and Dow Jones Islamic Index for Pakistan are used.

Findings

The study could not find empirical support for CAPM using Lintner (1965), Black et al. (1972) and Fama and Macbeth (1973) approach. Nonetheless, the relation between beta and returns is positive in up-market and negative in down-market. The results of Fama-French three-factor and five-factor models suggest that size premium is positive and significant for explaining the cross section of stock returns of small size stocks, whereas value premium is positive and significant for explaining the cross section of returns of high value stocks.

Practical implications

The results suggest that fund managers can use Shari’ah-compliant stocks for portfolio diversification and for offering specialized investments given the positive market excess returns and the existence of size and value premium on Shari’ah-compliant stocks.

Originality/value

This is the first study on Fama-French (2015) five-factor model for Islamic capital markets in Pakistan.

Citation

Shaikh, S.A., Ismail, M.A., Ismail, A.G., Shahimi, S. and Mohd. Shafiai, M.H. (2019), "Cross section of stock returns on Shari’ah-compliant stocks: evidence from Pakistan", International Journal of Islamic and Middle Eastern Finance and Management, Vol. 12 No. 2, pp. 282-302. https://doi.org/10.1108/IMEFM-04-2017-0100