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Asset pricing in an Islamic economy

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  • Yacine Hammami

Abstract

We define an Islamic economy as one with borrowing restrictions, no leverage, and no risk-free asset. We derive a consumption-based asset pricing model for this economy under standard preferences. We demonstrate that news to consumption growth is the main driver of Islamic financial markets, but the degree of borrowing constraints also affects the pricing of Islamic assets. Using Saudi Arabian data, simulations show that our model does a good job in matching the observed equity premium as well as the volatility of the market return. Our model implies that the price-dividend ratio predicts dividend growth, and as a result that prices are driven mainly by cash-flow news rather than by discount rate news. Empirical tests show that our model is consistent with the data.

Suggested Citation

  • Yacine Hammami, 2020. "Asset pricing in an Islamic economy," Applied Economics, Taylor & Francis Journals, vol. 52(29), pages 3106-3122, June.
    • Handle: RePEc:taf:applec:v:52:y:2020:i:29:p:3106-3122
    DOI: 10.1080/00036846.2019.1706715
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    Cited by:

    1. Jardine A. Husman & Ali Sakti & Dahnila Dahlan & Imam Wahyudi Indrawan & Zaäfri A. Husodo & Nur Dhani Hendranastiti & Muhammad Budi Prasetyo & Wahyu Jatmiko, 2022. "On The Development Of The Islamic Benchmark Rate: An Indonesian Case," Working Papers WP/04/2022, Bank Indonesia.

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