Downside Risk Measures Incorporated in Islamic Capital Asset Pricing Model

Abstract

This study attempts to examine different risk measures and their combinations as the part of a suitable asset pricing model for Islamic stocks. We choose beta, coskewness, downside beta, and downside coskewness and their combinations in single- and two-factor asset pricing model settings. We selected 91 companies from PSX using monthly returns from 2000-2018. The double sorting procedure is adopted for robustness, and collinearity between beta/downside beta and its respective higher moments is addressed by orthogonalizing each variable with its counterpart. Results tend to indicate that the two-factor model comprising downside beta and downside coskewness-based model is the most suitable asset pricing model for Islamic stocks. The use of two risk measures in the Islamic asset pricing framework yields a better understanding of stock prices which can help assess the risk of Islamic stocks for an investment decision.