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Prudence and temperance in portfolio selection with Shariah-compliant investments

Prudence and temperance in portfolio selection with Shariah-compliant investments This paper aims to explore the impact of Sharīʿah-compliant stocks on other investor risk preferences beyond the risk aversion, namely, prudence and temperance.Design/methodology/approachThis paper uses the non-parametric model data envelopment analysis with the shortage function as a measure of performance. The model uses three specifications considering skewness and kurtosis that describe according to expected utility theory, prudence and temperance.FindingsResults show that first, efficient portfolios consist mainly of conventional stocks in the three-model specification. Second, the skewness improvement is achieved only when considering conventional stocks while Sharīʿah-compliant assets do not exhibit any impact on the third moment. Finally, diversification through both conventional and Sharīʿah-compliant stocks does not lead to kurtosis reduction. Sharīʿah-compliant stocks in efficient portfolios are sensitive to return and risk solely, and hence, prudence and temperance as related to skewness and kurtosis measures can be ignored in optimal portfolio selection during normal market conditions.Research limitations/implicationsFindings suggest the same conclusions for four Islamic screening methods; however, readers should be prudent due to the limited sample. Results show that Sharīʿah-compliant assets do not have an impact on higher-order moments optimal portfolio returns, and hence, question the commonly admitted assumption of non-normality return distributions at least for Sharīʿah-compliant stocks.Practical implicationsThe research findings suggest that Islamic investor preferences are described only by return and risk along with Sharīʿah criteria for stock selection and portfolio allocation. Portfolio managers should not care about higher-order moments to manage Sharīʿah-compliant funds. The traditional mean-variance Markowitz framework will be sufficient for investment or allocation decision-making. Description of Sharīʿah-compliant portfolio returns with only the first two order moments gives such asset more resiliency to extreme events like a crisis.Originality/valueThis research is the first in literature exploring whether prudence and temperance defined by higher-order moments can be drivers, besides Sharīʿah criteria, in portfolio allocation decision-making. This study is unique in terms of methodology and application. It uses individual stock data on the Casablanca Stock Exchange. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png International Journal of Islamic and Middle Eastern Finance and Management Emerald Publishing

Prudence and temperance in portfolio selection with Shariah-compliant investments

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Publisher
Emerald Publishing
Copyright
© Emerald Publishing Limited
ISSN
1753-8394
DOI
10.1108/imefm-07-2019-0292
Publisher site
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Abstract

This paper aims to explore the impact of Sharīʿah-compliant stocks on other investor risk preferences beyond the risk aversion, namely, prudence and temperance.Design/methodology/approachThis paper uses the non-parametric model data envelopment analysis with the shortage function as a measure of performance. The model uses three specifications considering skewness and kurtosis that describe according to expected utility theory, prudence and temperance.FindingsResults show that first, efficient portfolios consist mainly of conventional stocks in the three-model specification. Second, the skewness improvement is achieved only when considering conventional stocks while Sharīʿah-compliant assets do not exhibit any impact on the third moment. Finally, diversification through both conventional and Sharīʿah-compliant stocks does not lead to kurtosis reduction. Sharīʿah-compliant stocks in efficient portfolios are sensitive to return and risk solely, and hence, prudence and temperance as related to skewness and kurtosis measures can be ignored in optimal portfolio selection during normal market conditions.Research limitations/implicationsFindings suggest the same conclusions for four Islamic screening methods; however, readers should be prudent due to the limited sample. Results show that Sharīʿah-compliant assets do not have an impact on higher-order moments optimal portfolio returns, and hence, question the commonly admitted assumption of non-normality return distributions at least for Sharīʿah-compliant stocks.Practical implicationsThe research findings suggest that Islamic investor preferences are described only by return and risk along with Sharīʿah criteria for stock selection and portfolio allocation. Portfolio managers should not care about higher-order moments to manage Sharīʿah-compliant funds. The traditional mean-variance Markowitz framework will be sufficient for investment or allocation decision-making. Description of Sharīʿah-compliant portfolio returns with only the first two order moments gives such asset more resiliency to extreme events like a crisis.Originality/valueThis research is the first in literature exploring whether prudence and temperance defined by higher-order moments can be drivers, besides Sharīʿah criteria, in portfolio allocation decision-making. This study is unique in terms of methodology and application. It uses individual stock data on the Casablanca Stock Exchange.

Journal

International Journal of Islamic and Middle Eastern Finance and Management – Emerald Publishing

Published: Jul 27, 2021

Keywords: Sharīʿah-compliant stocks; Data envelopment analysis; Shortage function; Higher-order moments; Prudence; Temperance

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