Ethical Stochastic Objectives Programming Approach for Portfolio Selection

The paper develops an ethical multiple stochastic objectives approach to address the ethical portfolio selection problem in the stochastic environment under the Shari’ah compliant framework. Two random objectives considered in this paper which are maximizing portfolio return and maximizing social welfare of portfolio. The risk of portfolio is measured by covariance matrix of total return. The ethical stochastic objectives program approach is based on goal programming approach, a chance constrained approach and Shari’ah compliant framework. The model is applied on 60 stocks including conventional and Islamic securities in GCC. The results show that, portfolios with higher proportion of ethical Islamic securities in the portfolio and with higher expected loss the higher is the portfolio performance in terms of Sharpe measure. Keywords: Shari’ah compliant, Ethical investment, Goal programming, Multiple objectives, Stochastic Multiple objectives programming, Chance constrained approach, Sharpe index as portfolio performance measure

A new class of Shariah-compliant portfolio optimization model: diversification analysis

This study proposes a novel Shariah-compliant portfolio optimization model tested on the daily historical return of 154 Shariah-compliant securities reported by the Shariah Advisory Council of Securities Commission Malaysia from 2011 to 2020. The mathematical model employs an annual rebalancing strategy subject to a Conditional Value-at-Risk (CVaR) constraint while considering practical and Islamic trading concerns, including transaction costs, holding limits, and zakat payment. To validate the model, the optimal portfolios are compared against an Islamic benchmark index, a market index, and portfolios generated by the mean-variance model, as well as a forecast accuracy test by the Mean Absolute Percentage Error and Mean Absolute Arctangent Percentage Error. Furthermore, this study examines the inter-stock relationship within the generated portfolios using correlation and Granger causality tests to identify the diversification performance. Results show an outperformance of the model in offering portfolios with higher risk-adjusted returns under a comparably short computational time and an indication of generally well-diversified portfolios by the weak correlations between securities. The study further noted that the model is adept at risk management in addition to higher forecast accuracy during financial crises by showing remarkably fewer causal relationships during bear markets in 2011, 2014, and 2020. The findings of an inversed relationship between portfolio risk and the number of causalities between securities offer new insights into the effect of dynamic relationships between securities on portfolio diversification. In conclusion, the proposed model carries higher moral and social values than the conventional models while portraying high potential in enhancing the efficiency of asset allocation, contributing to economic diversification and the scarce literature on Islamic portfolio optimization modelling. The study also supports the substantially increasing demand for Shariah-compliant strategies following globalization and the changing demographic of the real financial world with growing priorities of social and sustainability values

Risk Modelling in Shariah Compliant Investment and Insurance Products

The main objective of this study is to develop a risk model for Shariah (Islamic) compliant investment and insurance. Islamic finance is a part of Socially Responsible Investment (SRI) that incorporates religious ethics. In the first part, we propose a portfolio optimization model that complies with Shariah rules. Motivated by the Markowitz's mean variance model, this study proposes a new portfolio optimization model that takes into consideration both processes of purification and screening, which are key to constructing a Shariah-compliant portfolio. The model reflects the stochastic nature of purification and applies to both investment and dividend purification. Recognizing the importance of on-going screening and that assets that subsequently become non-compliance during the investment horizon could adversely affect the portfolio strategy, we impose probabilistic constraints to control the risk of compliance change. We conduct an extensive empirical study using a sample of Shariah-compliant public companies listed on the Indonesia Stock Exchange. We evaluate our proposed model by formulating the probabilistic constraints at both asset and portfolio levels, together with three different financial screening divisors that are broadly used by the international Shariah boards. The empirical results demonstrate that the effect of imposing non-compliance probabilistic constraints is highly sensitive to the adopted divisors and that these constraints can be an effective way of mitigating the risk of compliance change, thereby avoiding involuntary asset liquidation, and enhancing the performance of the resulting Shariah-compliant portfolio. We extend the Shariah portfolio model to the multiperiod problem consisting of a risk-free asset and risky assets in the second part of this thesis. We assume geometric Brownian motion to capture the dynamic of purified asset return, and we apply two assumptions for the dynamic of the screening financial ratio. In the first one, we assume that the financial ratios are independent and follow beta distributions. The second assumption relaxes the independence assumption by allowing the financial ratios to follow the Beta-AR(p,q) model. We also take into account other Shariah constraints, namely no-short selling and no-leverage restrictions. We solve the multiperiod mean-variance Shariah portfolio problem using a pre-commitment approach and adopt the multi-stage strategy following by Stochastic Grid Bundling Method (SGBM) to find the optimal asset allocations. Finally, we apply the proposed algorithm to generate Shariah portfolio efficient frontiers for multiperiod time cases to see the impact of each Shariah variable on the performance of the portfolio. The empirical simulations show that the proposed probabilistic Shariah screening constraint is efficient in maintaining the sustainability of the asset in the portfolio. In the third part of this study, we construct a new risk model representing the Hybrid-Takaful (Islamic Insurance) framework and develop a computational procedure to calculate the associated ruin probability. The Hybrid-Takaful business model applies a Wakalah (agent-based) contract for underwriting activities and Mudharabah (profit sharing) contracts for investment activities. We consider the existence of the qard-hasan facility provided by the operator (shareholder) as a benevolent loan for participants' fund in case of a deficit. This facility is a no-interest loan that will be repaid if the business generates profit in the future. For better investment management, we propose a separate investment account of participants' fund. We implement several numerical examples to analyze the impact of several parameters on the Takaful business model. We also find that our proposed Takaful model has a better performance compare with the conventional counterpart in terms of the probability of ruin. At the end of this thesis, we describe the conclusions and possible future research topic for each component of this thesis