Are Dow Jones Islamic equity indices exposed to interest rate risk?

Abstract

This study is the first attempt to evaluate the interest rate sensitivity of return and volatility of the Dow Jones Islamic Market Indices. These indices are constructed by screening out stocks that are incompatible with Islam’s prohibition of interest and certain lines of business. However, as a blunt instrument, the interest rate can affect discounted cash flows of any firm, even a firm with little or no financial leverage. This study observes that Islamic equity index portfolios outperform their conventional counterparts in both raw and risk-adjusted returns. A novel finding of this study is that the aggregate portfolio of Islamic stocks is immune to both the change in the interest rate and the volatility of the interest rate. However, returns on some Islamic-sector portfolios are sensitive to long-term interest rates but to a lesser degree than their conventional counterparts