The rapid proliferation of Islamic-oriented investments has placed an added urgency on better understanding their risk profile. With respect to Islamic stock market indexes, this concern is more pertinent to the extent that indexes could be subject to manipulation, and because they are often used as a benchmark for Islamic mutual funds. Using the Capital Asset Pricing Model as the basis, the paper places the most popular Islamic index under analytical scrutiny, and asks the following:
how has the Sharia selection restriction affected its performance?
what is the competitive risk-return tradeoff of a Sharia-compliant index?
to what extent is a Sharia-compliant index correlated with the broad stock market?
The results show the following:
the total fluctuations in the DJI have been in line with other indexes, both broader (the Dow Jones World index) and restricted (the socially responsible index or “Green”)
with respect to the behavior of the DJI relative to stock markets worldwide, and specifically for its use as a benchmark by Islamic mutual funds, the results indicate a competitive risk adjusted return and a performance that mirrors one of the largest and most comprehensive measures of equity prices available today
funds that closely track the DJI index expose their clients to no more risk than what these individuals could achieve in the broad stock market without the moral restriction that the DJI imposes on itself
Finally, there is no evidence that the compliance to Sharia, as interpreted by the DJI, has resulted in any discernible costs to investors. Testing of the conditional Capital Asset Pricing Model confirmed the results, the applicability of a linear risk return trade-off for the DJI and the use of beta as a relative market risk indicator.