On the relevance of higher-moments for portfolio-management within Islamic finance

Abstract

Purpose

Using a convenient tail-risk measure of performance, this paper aims to explore the extent to which incorporating higher statistical moments such as an assets skewness and kurtosis, provides further insight into the potential benefits of asset-class diversification within the realm of Islamic finance.

Design/methodology/approach

The authors use Engle’s (2002) DCC-GARCH model to study the dynamic conditional correlations between asset classes. Furthermore, the authors use the modified value-at-risk (Favre and Galeano, 2002), which incorporates higher statistical moments, to measure the performance of portfolios during both crisis and bullish regimes.

Findings

The most important finding relates to the estimation of portfolio tail-risk. In particular, the authors find that using a standard two-moment value-at-risk (VaR) measure, which assumes normally distributed returns, rather than a four-moment VaR, which incorporates an asset skewness and kurtosis, can lead to a substantial underestimation of portfolio risk during the most extreme market conditions.

Originality/value

This paper contributes to the extremely limited research considering higher-moments within the realm of Islamic portfolio-management. The results suggest that Islamic portfolio managers should remain cognisant of the skewness and kurtosis parameters of their assets. Ignoring higher-moments could induce misleading inferences and would, therefore, constitute imprudent risk-management.

Citation

Shaikh, O. (2020), "On the relevance of higher-moments for portfolio-management within Islamic finance", International Journal of Islamic and Middle Eastern Finance and Management, Vol. 13 No. 3, pp. 533-552. https://doi.org/10.1108/IMEFM-11-2018-0388