Markowitz-based Shariah compliant portfolio model with stochastic purification and probabilistic compliance screening constraints

What is it about?

In this paper, we have proposed an effective Shariah-compliant portfolio model that is more consistent with the current practice. It has the desirable features of incorporating both stochastic purification and non-compliance probabilistic constraints. The former addresses the constant purification rate that is commonly assumed in the existing literature, while the latter provides an effective way of controlling the non-compliance risk, which can have an adverse effect on the portfolio strategy. The conducted empirical studies affirm the importance of these features. In particular, they show that the effect of imposing non-compliance probabilistic constraints is highly sensitive to the adopted divisors and that these constraints can be an effective way of mitigating the risk of compliance change, thereby enhancing the effectiveness of the resulting Shariah-compliant portfolio. For future work, it will be of interest to extend the non-compliance probabilistic constraints to a portfolio model in the multiperiod setting, within which the adverse effect due to risk of compliance change will be even more pronounced.

Featured Image