Does Shariah compliance make interest rate sensitivity of Islamic equities lower? An industry level analysis under different market states

This paper examines the sensitivity of the Dow Jones Islamic market index and its corresponding industry equity indices to changes in the level, slope and curvature of the U.S. term structure of interest rates over the period 1996–2015 using the quantile regression approach. The empirical results reveal that the Islamic stock market has a considerable negative exposure to interest rate risk, although a declining time pattern of interest rate sensitivity is observed. The unexpected changes in the level factor of the U.S. yield curve, closely linked to long-term interest rates, are identified as the most important interest rate factor in explaining the variability of Islamic equity returns. Furthermore, the interest rate exposure tends to be stronger during extreme bearish conditions in the stock market, possibly due to the greater pessimism and risk aversion under these market circumstances. It is also shown that Islamic equities are not different from their mainstream counterparts in terms of interest rate sensitivity, indicating that the Islamic stock market does not provide a cushion against interest rate risk.