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Journal of Economics and Finance

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20-03-2021

Sukuk and bond spreads

Authors: Faruk Balli, Hassan Ghassan, Essam H. Al Jeefri

Published in: Journal of Economics and Finance | Issue 3/2021

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Abstract

Sukuk are considered as an alternative instrument in Islamic finance. However, the structures and provisions make sukuk dissimilar to bonds. Literature is having difficulty in the comparison between the performance/integration of the sukuk and bonds issued at the same time. To fill the existing literature gap on sukuk risk, we focus on the yield spread by comparing the sukuk yield to bond yield through their main determinants by using the data of financial and non-financial firms at weekly level. We use 123 firms that issued both sukuk and bond at the same period for years between 2013 and 2018. We employ sukuk and bonds data that are issued by same company and issued at the same period and market. Accordingly, we are able to minimize factors that raised from sukuk and bonds structure differences. Using the panel generalized least squares estimations, we find that global factors, such as US government yield bonds make significant impact on the sukuk-bond differences. In particular, the negative returns create more significant differences. However, on the other hand, the global shocks in sukuk markets, proxied by DJ sukuk index, are highly limited. By using the quantile analysis, we find that the effects of higher or lower bond spreads do not change.

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Sukuk and bonds have similar characteristics such as payment streams, secondary markets etc. However, there are also some big differences. Bonds are debt obligations whereas sukuks are based on asset ownership. The return in fixed for conventional bonds with interest rate whereas sukuks can appreciate/depreciate and return can be higher or lower. Lastly, values of the sukuk determined by the values of the assets backing sukuks, whereas price of bonds is determined by basic risk factors.

For more details on Malaysian sukuk markets see Mohamed et al. (2015). They mentioned that Malaysia is among the largest sukuk markets in the world. The fact is, for around 2020, the federal government has set an objective for Islamic banking utilities to attain 40% of the entire industry.

The maturities of sukuk vary from medium to long term. Most of sukuk certificates are being held until their maturity.

Such strategies consist in buying past winners securities and selling past losers securities.

This definition of the yield spread is also adopted by Yu (2005), where the yield spreads correspond to a difference between corporate bond yield and the US treasury bond yield of matching maturity.

We suggest that the specific sukuk, linked to fundamentals, would be a potential solution for debt burden in Europe.

For more details see: https://en.wikipedia.org/wiki/Sukuk

Ayturk et al. (2017) do not take into account the heterogeneity in their panel, the exogeneity of the explanatory variables and the heteroscedasticity of residuals, this weakness and due to applying OLS estimation method, their findings remain not robustly conclusive.

For more details, see the link: https://www.investment-and-finance.net/islamic-finance/w/wakalah-sukuk.html

Such methods of estimation are commonly used by Siklos (2011) and Klepsch and Wollmershäuser (2011). Afonso et al. (2015) used General to Specific (GS) methodology by applying different rolling estimation to their autoregressive fundamental equation.

When cross observations \(N\) are less than time series observations \(T\) and there is serial correlation between spread data of sukuk and bond returns of firms, stochastic errors would have a matrix of variances-covariances \(\Omega \otimes T\), with \(\Omega =\left({\sigma }_{ij}\right)\), \(i,j=1,\dots ,N\) where \({\sigma }_{ij}\) is not necessarily null (Heij et al. 2004). These characteristics lead to use GLS models by controlling for firm heterogeneity and providing more efficient point-estimates.

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Title: Sukuk and bond spreads
Authors: Faruk Balli
Hassan Ghassan
Essam H. Al Jeefri
Publication date: 20-03-2021
Publisher: Springer US
Published in: Journal of Economics and Finance / Issue 3/2021
Print ISSN: 1055-0925
Electronic ISSN: 1938-9744
DOI: https://doi.org/10.1007/s12197-021-09545-9

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