On the relevance of higher-moments for portfolio-management within Islamic finance

Omar Shaikh

International Journal of Islamic and Middle Eastern Finance and Management, 2020, vol. 13, issue 3, 533-552

Abstract: Purpose - Using a convenient tail-risk measure of performance, this paper aims to explore the extent to which incorporating higher statistical moments such as an assets skewness and kurtosis, provides further insight into the potential benefits of asset-class diversification within the realm of Islamic finance. Design/methodology/approach - The authors useEngle’s (2002)DCC-GARCH model to study the dynamic conditional correlations between asset classes. Furthermore, the authors use the modified value-at-risk (Favre and Galeano, 2002), which incorporates higher statistical moments, to measure the performance of portfolios during both crisis and bullish regimes. Findings - The most important finding relates to the estimation of portfolio tail-risk. In particular, the authors find that using a standard two-moment value-at-risk (VaR) measure, which assumes normally distributed returns, rather than a four-moment VaR, which incorporates an asset skewness and kurtosis, can lead to a substantial underestimation of portfolio risk during the most extreme market conditions. Originality/value - This paper contributes to the extremely limited research considering higher-moments within the realm of Islamic portfolio-management. The results suggest that Islamic portfolio managers should remain cognisant of the skewness and kurtosis parameters of their assets. Ignoring higher-moments could induce misleading inferences and would, therefore, constitute imprudent risk-management.

Keywords: Islamic finance; Portfolio diversification; Higher moments; DCC-GARCH; Value-at-risk; Sukuk; Commodities; Equities; Portfolio management (search for similar items in EconPapers)
Date: 2020
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Persistent link: https://EconPapers.repec.org/RePEc:eme:imefmp:imefm-11-2018-0388

DOI: 10.1108/IMEFM-11-2018-0388

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