Asset pricing factors in Islamic equity returns

Previous studies have compared risk–return characteristics of Islamic equity indices with their conventional counterparts, which may produce spurious results because a conventional equity index includes both Islamic and non-Islamic constituents. Hence, this study compares Islamic equity portfolios with their non-Islamic counterparts. We find that aggregate Islamic equity portfolios generally outperform non-Islamic equity portfolios after controlling for the five asset pricing factors—market, size, value, profitability, and investment (Fama and French, 2015). The average cost of equity is 2.77 percentage points lower for Islamic firms compared to non-Islamic firms. The findings hold for the various segments of the global equity market, and remain robust when the interest rate-augmented and the liquidity factor-augmented versions of the Fama–French five-factor model are employed. The GRS test results suggest these asset pricing models may not be adequate for pricing both Islamic and non-Islamic equities.