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Global sukuk
Comparative analysis between and bond
global sukuk and bond indices: indices

value-at-risk approach
Rubaiyat Ahsan Bhuiyan and Maya Puspa 1245
Faculty of Economics and Management Sciences,
International Islamic University Malaysia, Kuala Lumpur, Malaysia Received 8 February 2018
Revised 14 December 2018
20 March 2019
Buerhan Saiti 21 May 2019
Department of Islamic Economics and Finance, Accepted 21 May 2019

Istanbul Sabahattin Zaim University, Istanbul, Turkey, and

Gairuzazmi Mat Ghani
Faculty of Economics and Management Sciences,
International Islamic University Malaysia, Kuala Lumpur, Malaysia

Abstract
Purpose – Sukuk is an innovative financial instrument with a flexible structure based on Islamic financial
contracts, unlike a bond which is based on the structure of a loan imposed with interest. With the notion that
sukuk differs considerably from the conventional bonds in terms of risks related to investment, this study
aims to examine whether the sukuk market is different from conventional bond markets based on the value-
at-risk (VaR) approach.
Design/methodology/approach – The VaR of a portfolio consists of sukuk and bond indices and is
undertaken to determine whether there is any reduction in the VaR amount through the inclusion of the sukuk
index in the portfolio. The analysis is undertaken based on the developed and emerging market bond and
sukuk indices from January 2010 to December 2015.
Findings – This paper examines whether the VaR of sukuk market differs from conventional bond markets
by using fundamental techniques. It was observed that the VaR amount of sukuk indices is comparatively
much lower than the VaR of bond indices in all the cases. Including the sukuk index with each bond index can
reduce the VaR of the portfolio by around 30 to 50 per cent for all the developed and emerging market bond
indices.
Research limitations/implications – This research is limited to covering six years of data.
Nonetheless, it is able to provide findings which are believed to be useful for the market players.
Practical implications – This study unveils attractive opportunities in terms of diversification benefits
of sukuk indices for international fixed-income portfolios.
Originality/value – The VaR method is a useful risk management tool. This study uses this method to
emphasise the significant reduction of risks and diversification benefits that sukuk investment could offer by
including it in the investment portfolio.
Keywords Sukuk, Bond, Value-at-risk, Portfolio management, Islamic finance
Paper type Research paper

Journal of Islamic Accounting and

Business Research
Vol. 11 No. 6, 2020
The authors are deeply grateful to Co-Editor Dr Mohammad Hudaiband and the anonymous pp. 1245-1256
reviewers for their helpful comments which improved the quality of the paper greatly. The authors © Emerald Publishing Limited
1759-0817
acknowledge and assume responsibility for any mistakes or errors within the manuscript. DOI 10.1108/JIABR-02-2018-0019
JIABR 1. Introduction
11,6 The sukuk market has recorded substantial and remarkable growth over the past decade. In
recent years, sukuk has gained more importance globally because of its significant
performance as a flagship Islamic capital instrument. The global sukuk outstanding topped
US$30bn as of November 2014 and experienced an 11.4 per cent increase from US$269.4bn
at the end of 2013. An increasing trend was observed in Malaysia’s secondary sukuk
1246 market, which was sizeable at approximately US$173.4bn at the end of 2014 with a 9.6 per
cent increase year-on-year. At the same time, the total GCC sukuk outstanding portfolio rose
by 6.4 per cent to US$90.8bn, compared with US$85.3bn outstanding at the end of 2013
(Malaysia International Islamic Financial Centre, 2014). In terms of share of the total
issuance among leading countries, Malaysia occupied 64.6 per cent, with Saudi Arabia (10.3
per cent), Indonesia (5.3 per cent), the UAE (5 per cent) and Turkey (3.6 per cent) rounding up
the top five markets, where it was observed that Malaysia continued to dominate the
market. However, the top five countries occupied approximately 95 per cent of the total
issuance in 2013, whereas it was reduced to 89 per cent in 2014, which indicates that the
sukuk market is distributed geographically. This is also a positive sign of expansion into a
new market.
A diverse investor base participated in the sukuk market, reflecting 29 per cent
investment from the USA, 39 per cent investment from the Middle East and Asia and 31 per
cent from Europe. The UK played a key role in Shariah-compliant finance in the eurozone
and issued its debut sukuk in 2014. As a whole, 19 countries tapped the sukuk market this
year, compared with 18 countries in 2013 reflecting mainly debut sukuk (Kuwait Finance
House Research Ltd., 2015) by the governments of the UK, South Africa, Pakistan, Hong
Kong, Senegal, Luxembourg and the Emirate of Sharjah. Also, the Central Bank of
Bangladesh issued a short-term sukuk to manage liquidity, which was a positive step for its
introduction into Islamic finance[1].
According to the Accounting and Auditing Organization for Islamic Financial
Institutions, sukuk can be described as “certificates of equal value representing undivided
shares in ownership of tangible assets, usufruct, and services, assets of particular projects or
special investment activity”. Conventional bonds differ significantly from sukuk in such a
way that the return to bondholders or investors signify the right to claim indebtedness for
borrowed money, whereas the return to sukuk holders signifies the right to avail payments
from a trade transaction and claim ownership of business venture or a specific asset (Kuwait
Finance House Research Ltd., 2015). Moreover, sukuk is an innovative financial instrument
having a flexible structure based on Islamic financial contracts, unlike a bond which is
based on the ancient structure of a loan imposed with interest. Sukuk is not an interest-
based financial instrument but one that promotes real economic activities and generates a
return based on sharing or leasing acceptable assets (RAM Rating Services Berhad, 2008).
Furthermore, sukuk differs considerably from conventional bonds in terms of risks
related to investment. Sukuk is influenced by the Shariah compliance risk, which is
associated with the structure that originates from the usage of Islamic finance contracts.
Apart from this, sukuk faces similar risks associated with bonds such as credit risk,
business risk, foreign exchange risk, liquidity risk, commodity risk and market risk which
are considered an interest rate risk and equity price risk (Tariq, 2004).
Turbulence in the global financial market in 2007/2008 had set off a sporadic pattern
which affected the yields of the treasury bills, government and corporate bonds globally as
an after-effect of the quick changes in monetary policy. For instance, the yield on the US 10-
year treasury bill descended from its top of 4.27 per cent in June 2008 to its record drop to a
low of 2.05 per cent in December 2008[2] when the interest rate was reduced as the primary
remedial measure to assist economic activity using financing and customer spending Global sukuk
mechanisms[3]. The same example was also seen in the European Union and the UK where and bond
long-haul sovereign security yields lost by more than 150 basis points, whereas Japan’s
yields plunged by 60 basis points from their peak in 2008 (Wilson, 2010). Moreover, the
indices
global effects brought about by the financial crisis provoked numerous researchers to
examine the Islamic financial system. Smolo and Mirakhor (2010) observed that the Islamic
financial industries were protected from the crisis because of the fundamental Shariah
restriction prohibiting riba (Interest) and gharar (pointless fallacy). Smolo and Mirakhor 1247
(2010) affirmed that the impermissibility and consequently, inaccessibility of financial
derivatives, such as the Collateralized Debt Obligations, may have been a vital contributor
to protecting the Islamic financial system from suffering the vast effects of the crisis.
Therefore, we are wondering whether sukuk has similar a risk-return profile to that of
bonds. The present study examines whether the value-at-risk (VaR) of sukuk market differs
from conventional bond markets by using fundamental techniques. It also examines the
VaR of a portfolio consisting of sukuk and bond indices to determine whether there is any
reduction in VaR amount through the inclusion of sukuk index in the portfolio.
Section 2 highlights the literature on VaR and diversification benefits of sukuk and bond
markets. Section 3 provides detailed descriptions of the methodology used to investigate the
VaR of sukuk and the bond market portfolio. Section 4 contains a description of the data, the
application of the methodology and a detailed discussion of the findings. Section 5 concludes
the study. The implication of this research is also highlighted together with its limitations
and recommendations for future research.

2. Literature review
Sukuk gained more importance globally because of its significant performance as a flagship
Islamic capital instrument. Afshar (2013) uncovered the issue of compatibility of sukuk
instruments with conventional considering the structure and risk-return profile. The author
also addressed the issue from the investors’ and issuers’ perspectives, where both can
choose sukuk and conventional bonds because both financial instruments are successful in
generating capital for corporations and governments. However, these two instruments differ
in nature, given that sukuk instruments are based on equity, whereas conventional bonds
are debt-based instruments.
Most of the studies focused on a comparative analysis between sukuk and the
conventional bond market in terms of structure. A few empirical studies analysed the
risk and return profiles between the two. For instance, Zin et al. (2011) compared sukuk
and conventional bonds in the context of the Malaysian market and highlighted the
practices and prospects of sukuk in the Malaysian Islamic capital market. Furthermore,
Ariff and Safari (2012) investigated the existence of causality factors between the
performance of sukuk and conventional bonds which have similar yields and ratings
but discovered that there was no causality between the two. Lahsasna and Lin (2012)
investigated Shariah issues in sukuk structure and claimed that there were similarities
between sukuk and conventional bonds in terms of the late-payment penalty, trading of
debt-based sukuk, purchase undertaking in equity-based structure and ownership
status in the asset-based transaction. Fathurahman and Fitriati (2013) examined the
yields of sukuk and conventional bonds within the Indonesian bond market. The
researchers found a significant difference between the yields on sukuk instruments and
the conventional bonds. In addition, the yields on sukuk were greater than conventional
bonds. Ramasamy et al. (2011) examined sukuk in terms of duration and convexity
compared to government and corporate bonds and measured the sensitivity of sukuk
JIABR traded in Malaysia. The outcome of the study provided evidence that a sukuk holder
11,6 gets a higher return compared to government bonds and at a lower rate than
conventional bonds. Moreover, the author believed that a conventional bond is
relatively riskier compared with sukuk. Alswaidan et al. (2017) worked on the creation
of evidence-based risk management techniques in Islamic finance and the expansion of
ethical financial management. Their findings revealed that sukuk structures are
1248 directly related to sukuk risk profiles. Thus, sukuk structure risks are Shariah risks.
This study highlights a sukuk risk classification matrix based on an estimation of
sukuk structure risks.
Rahman et al. (2013) studied sukuk spreads applying the generalized autoregressive
conditional heteroskedasticity (GARCH) method. This study examined factors that
influenced sukuk spreads and its volatility, which has contributed to the empirical
literature related to Islamic financial markets. It uncovered the underlying factors which
influenced risk management and pricing of sukuk instruments. Moreover, the authors
assessed the impact of the recent financial crisis on the behaviour of sukuk spreads and
pre-empted the effects of future financial shocks on the Islamic bond market. Godlewski
et al. (2013) examined the behaviour of Malaysian investors to the declaration of
conventional bonds and sukuk issuance. The study observed that the stock market
responded negatively to the declaration of sukuk issuance. On the other hand, it was
neutral to the announcements of conventional bond issuance. Also, the authors
emphasised that there were excessive demands for sukuk securities, and the adverse
selection mechanism showed that lower-company debtor firms are the issuers of sukuk
certificates. A recent study also highlighted the influence of macroeconomic factors on
sukuk market development. Ahmad et al. (2012) examined the effect of macroeconomic
factors on sukuk issuance in the Malaysian capital market at the aggregate level. The
outcome of the study showed that sukuk Granger-caused gross domestic product (GDP)
whereas GDP Granger-caused consumer price index and producer price index, and in the
short horizon, sukuk are influenced by their own dynamics. Because GDP is Granger-
caused by sukuk issuance, this is a very important finding for decision makers for
designing and developing the functional features of the capital market.
In the case of other aspects of sukuk research, Ben Jedidia Khoutem (2014) studied the
opportunities of Islamic finance in spurring economic development in Tunisia after the
revolution of 2011. Precisely, this paper explores whether the Islamic banks-sukuk markets
relationships are conducive of economic growth. The study finds that the “marketable
Islamic intermediation” provides more funds to finance economic development and solve the
problems of poverty and unemployment. Sherif and Erkol (2017) examined the stock market
effects of announcements by firms to issue conventional bonds versus sukuk. In addition,
the authors investigated whether the choice of instrument depends on the tax status and
government backing of the issuing firm. Razak et al. (2018) examined the contracts,
structures and pricing mechanism of sukuk. More specifically, their study investigated
several sukuk instruments, reviewed the existing structures, demonstrated sukuk pricing
mechanisms and discussed critical issues of each type of sukuk.
Bhuiyan et al. (2019a) studied the market links (and price discovery) between global
sukuk by using the wavelet approach, which has recently been imported to finance from
engineering sciences. Hamzah et al. (2018) investigated the extent of risk-shifting behaviour
in bonds and sukuk. The examination is significant, as economists and scholars identify
risk-shifting as the primary cause of the global financial crisis. Bhuiyan et al. (2018, 2019b)
examined the volatilities and correlations of bond indices of emerging and developed
counties by applying wavelet coherence and multivariate GARCH analyses.
 A handful of studies engaged in portfolio’s risk analysis of sukuk and bond applying the Global sukuk
VaR approach. To this end, Raei and Cakir (2007) examined the impact of sukuk on the cost and bond
and risk structure of investment portfolio applying the VaR methodology. The authors indices
found different behaviour while comparing sukuk with Eurobonds issued by the same
issuer. However, the portfolio’s risk can be minimised by incorporating sukuk along with
bonds. Paltrinieri et al. (2015) examined the VaR of sukuk and bond indices using the delta-
normal VaR approach and found results similar to those of Raei and Cakir (2007). The 1249
findings implied that the sukuk index confirmed a lower level of risk measures. Moreover,
lower volatility contributed to lower risks together with the low correlation in the portfolios.
In Hassan (2012), the diversification benefit of the fixed-income portfolio was examined to
compare between conventional bond and sukuk by adding and omitting sukuk in the same
portfolio. In a recent study, Nasir and Farooq (2017) showed the comparative risk analysis of
sukuk and bonds in Pakistan. The VaR approach was used to calculate the risk of two
portfolios constructed separately with equal investments. The findings revealed that bonds
are riskier and less stable compared with sukuk. It was also found that most of the sukuk
securities are negatively or less-correlated to the constructed portfolio. In this study, we
examine the VaR of a portfolio which consisted of sukuk and bond indices and determined
whether there is any reduction in the VaR amount through the inclusion of the sukuk index
in the portfolio.

3. Methodology
3.1 Value-at-risk method
The VaR measures the worst expected loss of a portfolio over a certain holding period at a
given confidence level under normal market conditions (Jorion, 2006). In other words, VaR is
an expression of the portfolio’s market risk, representing the maximum amount which may
be lost, during a holding period, in all but (say) 1 per cent of cases. For example, the VaR
method can state with either 1 per cent probability or a 99 per cent confidence level that a
certain amount of dollars will be lost in each day, month or year. Various methods, including
simulation techniques, are applied to estimate the distribution of future portfolio values and
to calculate the possible losses by using historical data. VaR is based on the variance of the
return on the portfolio:
X 0
s 2P ¼ w w; (1)

where:
w = vector of weights for the various securities in the portfolio;
w 0 = transposed vector of weights in the portfolio;
R = variance-covariance matrix of returns on securities in the portfolio; and
s 2P = standard deviation of the portfolio.
The VaR of a portfolio can be constructed from a combination of the risks of underlying
securities. In other words, it constitutes the envelope for the volatility of, and
correlation among, various risk variables over time. Several methods can be used to
calculate VaR.
The variance-covariance approach, also called the delta-normal approach, is a
commonly used method. The basic assumption in this method is that returns are
jointly normally distributed. The normal curve conveniently enables us to determine
where the worst 5 and 1 per cent lie on the curve, depending on the confidence
JIABR interval, mean and standard deviation. Hence, we can calculate the portfolio VaR by
11,6 using the equation:
 
VaRp ¼  m p  a s p W (2)

where:
1250 a = standard normal deviate (e.g. 2.33 for the 99 per cent confidence level);
m p = average return of the portfolio; and
W = initial portfolio value.
As it is clear from the formula for the VaR of an asset, lower volatility implies a smaller VaR,
which is desirable. In the case of a portfolio of assets, lower volatility is obtained if the
returns of constituent assets have small or even negative correlations. Gains from
diversification arise by diversifying the portfolio to assets whose returns are not highly
positively correlated.
The normality assumption makes the VaR computation convenient although it has some
drawbacks. Contrary to the symmetry embodied in the normal distribution, asset returns
diverge from symmetry in two common ways. Fat tails are common in asset returns,
meaning that extraordinary losses may happen more frequently than a normal distribution
predicts. Moreover, asset returns are often negatively skewed, with more observations on
the left-hand side than on the right-hand side (Jorion, 2006).
In contrast to the delta-normal method, historical simulation is the simplest approach
among other methods to estimate VaR of a portfolio. This approach works based on
historical changes in the market price to identify probable future losses and profits. This
approach involves accumulating the set of risk factor changes over a historical period, such
as daily fluctuations over the last 10 years. This approach assumes a set of scenarios, which
is a good representation of all outcomes that could happen between today and tomorrow.
The instruments in the portfolio are repetitively re-valued against each of the scenarios.
This helps to produce a distribution of portfolio values or distribution of changes in portfolio
value from today’s value. Commonly, some of these fluctuations will involve losses and
some changes will involve profits. This study estimated the VaR of a portfolio from the
maximum loss associated with the required statistic likelihood percentile.
The main advantage of historical simulation is that it is considered a non-parametric
method because it does not hold any assumption on a probability distribution, such as the
distribution of returns or risk factors. Nonetheless, it assumes there will be a repetition of
previous historical events in the near future. Another significant advantage is that it does
not include the estimation of any statistical parameters like variance or covariance. Finally,
this approach is easy to explain and defend to an important and non-technical audience,
such as the board of directors.
The limitation of the method is that it places equal weight on recent as well as past data
that may cause bias estimation if there are trends like high volatility, which exist in the
historical data. Moreover, it requires bulk data to detect rare events, and the past may have a
different sort of risk characteristic from the future. This study applied delta-normal and
historical simulation VaR methods to evaluate portfolio risk (Alexander, 2009).

4. Data and empirical results

4.1 Data
Data was collected from the Bloomberg and Datastream databases which covered the period
from January 2010 to December 2015. These bonds and sukuk indices were transformed to
bond market returns by computing the natural logarithmic differences of the daily bond or Global sukuk
sukuk prices, that is, return = ln (ppt1t ), where Pt and Pt–1 represents the bond or sukuk price and bond
index at time t and t-1, consecutively. The list of the indices and the respective symbols are indices
mentioned in Table I. The selected Bloomberg sovereign bond indices are a rule-based
market-value weighted index constructed to measure the fixed-rate local currency securities
publicly by respected countries. The selected Dow Jones Sukuk Index is constructed to
evaluate the performance of global Islamic fixed-income securities or sukuk. This index 1251
incorporates US dollar-denominated investment-grade sukuk issued in the global market.
Finally, the Thomson Reuters BPA Malaysia Government Sukuk Index includes the
Malaysia Ringgit dominated long-term investment graded Islamic bonds.

4.2 Findings
Before analysing the portfolios, this study provides a clear view of the VaR of individual
indices. The VaR was estimated for each bond and sukuk index applying the historical VaR
method. Here, it is observed that the VaR amount of sukuk indices is comparatively much
lower than the VaR of bond indices in all the cases. Moreover, the inclusion of sukuk index
with each bond index reduced the VaR around 30 to 50 per cent for all the developed, and
emerging market bond indices are highlighted in Table II. The historical simulation shows
that the inclusion of sukuk index improves the VaR significantly.
For analysis, hypothetical bond and sukuk portfolios were created with the same amount
of dollar values (US$1,000,000) offering different investment alternatives. Two types of the
portfolio were constructed with the first one created combining sukuk and bond indices in
the same portfolio, whereas the second one consisted of only bond indices. All six portfolios
were constructed to measure the VaR separately. As explained in the methodology section,
the variance-covariance matrixes were constructed to calculate the VaR. The confidence
interval and the value of the holding period have to be specified in the VaR method. The
selection of the holding period depends on the application. Though the industry uses daily
VaRs for its internal risk control (Hartmann et al., 2004), the Basel Committee has advised
banks to apply a holding period of 10 days as well as a 99 per cent confidence interval to
maintain the minimum regulatory capital requirement to safeguard from market risk. A 99

No. Indices Ticker

Developed market
1 Bloomberg US Government Bond Index BUSG
2 Bloomberg Canada Sovereign Bond Index BCAN
3 Bloomberg Germany Sovereign Bond Index BGER
4 Bloomberg UK Sovereign Bond Index BRIT
5 Bloomberg Australia Sovereign Bond Index BAUS
6 Bloomberg Japan Sovereign Bond Index BJPN
Emerging market
1. Bloomberg Singapore Sovereign Bond Index BSIN
2. Bloomberg Indonesia Local Sovereign Index BINDO
3. Bloomberg Malaysia Local Sovereign Index BMYR
4. Bloomberg S Korea Local Sovereign Index BKRW
5. Bloomberg China Local Sovereign Index BCGB
6. Bloomberg India Local Sovereign Index BINDI
7. Dow Jones Sukuk Index DJSUKUK Table I.
8. Thomson Reuters BPA Malaysia Sukuk Index TRBPAMGOVI List of indices
JIABR Individual VaR VaR: bond index % VaR: bond index %
11,6 No. Bond index for bond index with TRBPAMGOVI change with DJSUKUK change

1 BUSG 14171.7 7593.51 46.61 9172.98 35.27

2 BCAN 13089.8 6945.17 46.94 7762.76 40.69
3 BGER 18209.8 9304.92 48.90 9869.53 45.80
4 BRIT 23727.1 11990.3 49.46 12986.6 45.26
1252 5 BAUS 14609.3 7710.98 47.22 8574.47 41.30
6 BJPN 8141.66 4801.71 41.02 6013.08 26.14
7 BSIN 12589.8 7408.26 41.15 8283.92 34.20
8 BINDO 29966.6 16301.5 45.60 16611.4 44.57
9 BMYR 4360.91 4882.87 11.97 5074.81 16.37
10 BCGB 24357.4 12584.9 48.33 12940.6 46.87
11 BINDI 16662 8142.33 51.13 9317.28 44.08
Table II. 12 BKRW 11195.6 6569.9 41.31 7418.41 33.73
VaR estimation (five 13 DJSUKUK 7482.02 5248.983 29.84 – –
days) 14 TRBPAMG 5732.88 – – 5248.983 8.44

per cent confidence interval and five working days or a holding period of one week were
selected in this study. Limited liquidity of positions is a strong reason for not selecting a
daily holding period. The longer holding period was selected because of the relative
illiquidity of sukuk, which is clear from the ratio of traded days.
The results of VaR calculation are presented in VaR estimates, and VaR was computed
for a hypothetical portfolio worth of US$1,000,000. Here, three portfolios have been created
to calculate the VaR for developed market bond indices. The first portfolio consists of only
six bond indices, the second portfolio consists of six developed market bond indices along
with Malaysian sovereign sukuk index and the third portfolio is created by combining six
developed market bond indices and global sukuk indices. Another three portfolios are
constructed for the emerging market bonds following the same structure as the developed
market, and altogether six portfolios are created to measure the VaR to determine whether
sukuk plays a vital role in reducing the portfolio risk. These are presented in Table III.
The delta-normal method illustrates a VaR of US$10206.51 for the portfolio of all
developed market bond indices which means that the investor can be 99 per cent sure that
the market value of the portfolio will not fall below US$10206.51 within a week. In other
words, the loss is capped at US$10206.51 with a 1 per cent chance that it can lose more than
that. In contrast, a portfolio of Malaysia sukuk and bond stands at US$8582.21, which shows
that the two figures differ from each other. Hence, with the inclusion of the Malaysian sukuk
index in the portfolio, the probable loss is reduced to 15.91 per cent for the developed bond
market investors based on the delta-normal method. Similar results were found by

No. of
portfolios Index selection Portfolio construction ($1m)

Portfolio 1 Developed Market Bond indices Six indices weighted equally

Portfolio 2 Emerging Market Bond indices Six indices weighted equally
Portfolio 3 Developed Market Bond indices with Malaysia Sukuk Index Seven indices weighted equally
Portfolio 4 Developed Market Bond indices with Global Sukuk Index Seven indices weighted equally
Table III. Portfolio 5 Emerging Market Bond indices with Malaysia Sukuk Index Seven indices weighted equally
List of portfolios Portfolio 6 Developed Market Bond indices with Global Sukuk Index Seven indices weighted equally
combining the global sukuk index with bond indices that reduced 15.84 per cent in VaR in Global sukuk
the portfolio. and bond
4.2.1 Value-at-risk estimates
indices
Method Portfolio 1 Portfolio 2 Portfolio 3:
(1) Delta-Normal method:
 Developed Market 10206.51 8582.21 8589.32.
 Change 15.91 per cent 15.84 per cent. 1253
(2) Historical Simulation:
 Developed Market 12035.5 10283.2 10283.7.
 Change 14.47 per cent 14.47 per cent.

Method Portfolio 4 Portfolio 5 Portfolio 6:

(1) Delta-Normal method:
 Emerging Market 6932.31 6056.43 5765.374.
 Change 10.56 per cent 12.63 per cent

(2) Historical Simulation:

 Emerging Market 8373.1 6056.43 7723.28.
 Change 6.14 per cent 7.76 per cent

The delta-normal method implies comparable results for emerging markets as well. By
including the Malaysia sukuk index along with the emerging market bond indices in the
same portfolio, VaR is reduced from $6932.31 to $6056.43, which is a 12.63 per cent
reduction. Moreover, the VaR amount was reduced from $6932.31 to $5765.37 by combining
the global sukuk with the emerging bond market indices in a portfolio, whereas in terms of
percentage it is a 16.83 per cent reduction. It is observed that VaR of a portfolio which
consists of sukuk and bond together is statistically different from the VaR of the portfolio,
which consists of only bonds.
VaR estimates also presents the estimates of VaR using the historical simulation method.
The results differ to the delta-normal method, whereas the numbers are very close, which
indicate that the outcomes are robust to the method of calculation. The historical simulation
method also illustrates that the inclusion of sukuk also improves the VaR in the portfolio.
The decreases in the VaR amount stand at 14.47, 14.47, 6.14 and 7.76 per cent for the
developed and emerging markets, respectively.
This study illustrates that sukuk can be considered diverse instruments that provide less
risk of investment in a portfolio compared with bonds because of their different price
behaviour. If a fixed-income investor wants to allocate his investment in bonds, it is advised
that this investor incorporates sukuk in the investment portfolio, which can lead to gains in
the diversification benefits as evidenced by this study. If an asset is not perfectly correlated
with other assets in the portfolio, it is expected that some reduction in VaR might occur.
Although, some reduction in VaR can be gained by adding another instrument to the
portfolio in this study. However, the reduction in VaR in this study is because of not only the
inclusion of an additional instrument in the portfolio but also an outcome of the different
behaviour of sukuk prices in the secondary market in comparison with conventional bonds.
In this context, Godlewski et al. (2013) found that the investors responded differently to the
issuance of sukuk and bonds, whereas significant negative stock market responsiveness
was found for sukuk issuance, the market is not responsive to bond issuance. The findings
are similar to Raei and Cakir (2007) and Hassan (2012) who also found that inclusion of
JIABR sukuk in the portfolio reduces the VaR amount compared to a strategy of investing only in
11,6 conventional bonds.

5. Conclusion
This study provides a clear view of the VaR of individual indices. It estimated the five-
day VaR for each bond and sukuk indices by applying the historical VaR method. Here, it
1254 was observed that the VaR amount of sukuk indices is comparatively much lower than
the VaR of bond indices in all the cases. This can be because of the reasons that the
Islamic investments are better positioned because of the specific features of Islamic
investments such as, ethical and ratio screenings, exclusion of financial sectors, exclusion
of highly leveraged firms, the limit of interest-based leverage and, finally, exclusion of
using complex and intensive structured financial products, derivatives and other toxic
assets (Saiti et al., 2014). Moreover, the inclusion of the sukuk index with each bond index
reduced the VaR to around 30 to 50 per cent for all the developed and emerging market
bond indices.
This study applied two different methods to estimate the VaR of the portfolios. A
comparison of the two different approaches revealed that the inclusion of the Malaysian
sukuk index in the portfolio contributed to a 15.91 per cent reduction in VaR for the
developed market investors. The result is similar for the global sukuk index with a
reduction of 15.84 per cent in VaR. Moreover, the delta-normal method implies comparable
results for emerging markets as well. The results of the historical simulation are not similar
to the delta-normal method, whereas the numbers are very close, which indicate that the
outcomes are robust to the method of calculation. Hence, the results indicate that the VaR of
a portfolio consisting of sukuk and bonds is not similar to a portfolio which represents only
bonds.
Although there is some reduction in VaR which can be gained by adding another
instrument, this reduction is not because of adding an instrument in the portfolio; rather it is
an outcome of the different behaviour of sukuk prices in the secondary market compared
with conventional bonds. In relation to this, Godlewski et al. (2013) found that the investors
responded differently to the issuance of sukuk and bonds. Hence, sukuk can be considered a
different type of instrument compared with bonds because of their different price behaviour.
Finally, the VaR concept is a very useful tool for financial institutions with regards to their
risk management, and international fixed-income investors are advised to incorporate
sukuk in the investment portfolio along with bonds which may help to gain diversification
benefits as shown from this study.

5.1 Policy implications of the study

Diversification benefits cannot be supported theoretically without investigating the extent
of financial interdependence. In this context, this study uncovered the attractive
opportunities in terms of diversification benefits with credit quality and Shariah-compliant
financial sector exposure for investors who want to invest in fixed-income securities. An
effective diversification strategy will provide possible scope for markets to retain financial
stability and boost system efficiency, which is essential for policymakers, portfolio
managers and investors.

5.2 Limitations of the study

This research examined the financial market integration only at the bond index level.
Comprehensive studies can be conducted to analyse the market on a sectoral basis. This
study focused solely on the sovereign bond and sukuk markets while it is still essential to
investigate the corporate sukuk market. Another shortcoming of this study includes the lack Global sukuk
of data from a longer timeframe. This research covered only six years of data; however, a and bond
detailed study using data from a longer period is needed because it will provide an in-depth
analysis of sukuk markets. It will also be a practical step for future research in financial
indices
economics and international finance.

Notes 1255
1. World Bank, US Census Bureau (2013 estimate).
2. Data sourced from Bloomberg.
3. Federal Open Market Committee (FOMC) cut interest rate to 0.25 effective 16 December 2008
(Bloomberg).

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Further reading
Philippe, J. (2006), Value at Risk, McGrew-Hill, New York, NY.

Corresponding author
Buerhan Saiti can be contacted at: [email protected]

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