An analysis on the Malaysian sukuk spreads

Abstract

The topic on credit spreads have been one of the major focuses on the scope of finance and investment literature. Theoretical frameworks have shown that credit spreads (or bond spreads) are the risk premium reflecting the additional risks borne by the investors for holding corporate bonds and provide signals for the likelihood of default. With the importance of credit spreads in the pricing of corporate bonds and in reflecting investors` behaviours during the different states of the economy, many empirical studies have explored on the behaviour of the spreads as well as factors determining its changes focusing on the developed bond markets of the United States of America, Europe, Japan and Australia. Despite the fact that sukuk market has been growing rapidly in the past decade, analysis on sukuk spreads is still in scarcity. With the aim to enhance the understanding on sukuk spreads for the purpose of risk management, this study attempts to analyse on the trend, behaviour and influencing factors for the variations of sukuk spreads over the period of 2005 to 2011. Focusing on the Malaysian sukuk market, this study employs the generalised auto-regressive conditional heteroscedasticity (GARCH) method by Bollerslev (1986). Apart from exploring the main determinants for sukuk spreads, this method also allows analysing the volatility of sukuk spreads and whether it is affected by the recent 2007/2008 global financial crisis and the volatility of the Malaysian stock market. For a more robust analysis, this study compares the behaviour and influencing factors of sukuk spreads against bond spreads and takes into account both investment and non-investment grade securities. This study is among the first few to document that the movement of the interest rate and the anticipation on the direction of the short term rate are the most important determinants to influence the variation in sukuk spreads. In line with the pressing demand for more in-depth information on various dimensions of the sukuk market, this study enriches the literature on Islamic finance from the perspective of sukuk spreads analysis. In addition to that, this study is also beneficial to the investors, portfolio managers as well as regulators to better understand the underlying factors influencing the pricing and risk management of sukuk instruments