DEFAULT RISK IN ISLAMIC EQUITY RETURN (THE CASE of KUALA LUMPUR STOCK EXCHANGE)

Default risk is an important problem for the Islamic financial market particularly Islamic capital market. In Islamic capital market there are many instruments such as Islamic equity, Islamic bond, Islamic unit trust, and so on. All of this instrument have worked together to make a balance in Islamic financial market. If one of the instruments faces default problems so the other instrument will also get the effect of this case. This research tries to examine the impact of the default to the Islamic equity return. This research also study about the correlation between the size, book to market ratio (BM) and the default probability (DP). This research use Merton’s model to determine the probability default in Islamic capital market. This is the first research that uses the Merton’s model to determine and to predict the default probability of the Islamic company. To answer the research question this study focuses in Islamic capital market in Malaysia that well-known as a leader in Islamic finance. It uses regression to examine the impact of the size, BM to PD. In addition, to measure impact of the PD to Islamic equity return this research also uses regression model. This Research find several conclusions. First, size of Islamic company has negative influence to the PD. If the size of firm increases 1% the PD will decrease around 1.112E-05. Between size and PD there is medium correlation that is shown by the R square which is about 34.9%. Second, Book to Market ratio does not have significant correlation with the PD. Third, this research also finds that the PD does not have impact to the return of Islamic equity. It means that the default probability of Islamic companies in Malaysia does not have impact to the return of Islamic equity