Islamic finance benchmark : a possible solution revisited

Abstract EN

Financial Assets’ pricing benchmarks serve multiple purposes in financial markets and hence play a critical role.

First, they serve as a reference point for pricing instruments ; second, they reflect the opportunity cost and third, they serve as a reference rate for the relative performance of investment portfolios.

Hence, a benchmark that is transparent, liquid, easy to calculate and non-manipulative is considered critical for the efficiency of financial markets.

Recent scandal of LIBOR’s manipulation by Barclays bank emphasizes the importance of a non-manipulative benchmark.

In this paper, we propose an alternative pricing model and show how it could work to serve the purpose of a potential benchmark for pricing.

This model was proposed by Abbas Mirakhor (1996) by utilizing the concept of Tobin’s Q2 to arrive at the cost of capital (CoC) without resorting to fixed interest rate.

We have empirically tested the model on Malaysian firms.

To arrive at the CoC, we derived Q-ratios at firm level and aggregated the same at the industry level.

Our findings suggest that the model proposed by Mirakhor (1996) can be used to estimate CoC in an interest free economy.