Design and pricing of Islamic asset-based sukuk ̄ strips : an endeavour towards financial development

Abstract EN

Purpose: The efficiency of the Islamic Financial Industry suffers from a lack of liquidity instruments and shallow secondary markets.

This paper reviews the financial intermediation theory and the complementary role of debt and money markets towards the broader goal of allocative efficiency, asset transformation, and diversification for the welfare of all economic agents.

Separately Tradable Registered Interest & Principle (STRIPs), created by disintegrating coupon and principal payment to be traded as discount bonds, have been effectively employed in the west for liquidity management.

This paper proposes a novel idea of ij ̄arah s.uk ̄uk STRIPS (ISS) that splits the payoffs of ij ̄arah s.uk ̄uk.

Method: The design and pricing of ISS are modeled employing lease valuation, certainty equivalent (C.E.), and bootstrapping.

Instead of the prevalent capital asset-pricing model, volatility of ij ̄arah s.uk ̄uk payoffs is modeled using certainty equivalents, which extend the analysis to micro-level investor utility function.

Also, the viability of ISS design is substantiated by numerical illustrations.

Findings: We found that the proposed ISS can serve as a short-term liquidity management instrument, facilitate price discovery and define the term structure in Islamic debt markets.

For sovereign issues, ISS can enable efficient monetary policy transmission, market completeness, and public finances for the underdeveloped Muslim world.

Significance: To the best of our knowledge, this is the first study propos- ing the ISS as a financial innovation.

The ISS proposed in this study will be a valuable addition to the arsenal of Islamic Financial offerings - augmenting the financial deepening and development of Islamic Financial Markets.