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

a r t i c l e i n f o The Dow Jones Islamic Market indices (DJIMI) 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 no financial leverage. This study reveals that the aggregate portfolio of Islamic stocks is immune to interest rate risk. However, at the sectoral level some Islamic equity portfolios demonstrate exposure to interest rate risk. Overall, evidence of interest rate risk exposure is less pronounced among Islamic sector portfolios than that of their mainstream counterparts—the Dow Jones World sector indices. The results also hold when interest rate risk is assessed in terms of the sensitivity of the DJIMI return to changes in level, slope and curvature of the interest rate term structure. Islamic investment has received attention in financial press for withstanding the recent global financial market turmoil. In recent years the global market for Islamic financial services has grown between 10 and 15% annually, and contrary to popular beliefs, most of this growth originates from non-Muslim countries. Islamic assets under management have reached over US 3.5 trillion dollars. Islamic finance is guided by the principles of Islamic law (shariah), which prohibits interest (riba), excessive risk-taking (gharar), gambling (maysir), and promotes risk-sharing, profit-sharing, asset-backed financial transactions, and ethical investment. 1 Islamic investment can be regarded as a subset of the socially responsible or ethical investment universe. The growing demand for Islamic investment products is seen as new business opportunities by some, while others articulate concerns about the potential link between Islamic finance and political agendas (see Ilias, 2008; Kuran, 1995). The former view has been gaining momentum, which is evident from the burgeoning global interest in Islamic stock market indices, Islamic bonds (Sukuks), exchange-traded Islamic managed funds, Islamic insurance (Takaful), and the launch of the Islamic interbank benchmark rate (IIBR), among others. Subsidiaries of the mainstream global financial institutions such as Citibank, Barclays, Morgan Stanley, Merrill Lynch, and HSBC are now offering Islamic financial services. In the United Kingdom alone, about 20 conventional banks offer Islamic financial services. The Dow Jones Islamic Market Indices (DJIMI) were launched in 1999 to provide a global investable universe of stocks that comply with Islamic law (shariah). As of December 2013, the DJIMI includes 2177 stocks from 55 …