Risk and Return Under Sharia Framework: An Attempt to Develop Sharia Compliant Asset Pricing Model-SCAPM

Abstract

Islamic finance has shown tremendous growth in last two decades. By the end of December 2008, in more than 50 countries approximately 300 institutions are operating and they manage funds of US $951 billion. As IFIs are entering into equity market for investment hence guidance in the field of security pricing is required. There is a need to analyze the existing security pricing models within the filter of Sharia compliance and suggest an alternative where required. This study is an attempt to analyze the technical asset pricing models (CAPM, APT and multifactor models) based on behavior of stock market and macroeconomic factors, test the validity through Sharia compliance filter and suggest modification if required. Findings suggest that existing technical asset pricing models are very much applicable under Sharia frame work with a minor modification of risk free return because under Islamic financial system risk free return does not exist. Traditional CAPM is convertible into SCAPM by eliminating risk free return and including inflation charge.

Keywords: SCAPM, Islamic financing, APT, Security pricing, valuation

JEL Classification: G12, G32