Shariah Compliance Prediction Model for Shariah Compliant Stocks Based on Historical Discriminant Trend Analysis

ABSTRACT

Shari’ah stocks screening methodologies had a significant impact in the realm of Islamic finance portfolio stocks since the early 1990s. These enabled a more inclusive investment community among overall Islamic financial community that led to the growth of Islamic financial institutions including Islamic banks and takaful. Over the years different Shari’ah stocks screening methodologies have been developed by the leading indices in different jurisdictions both at the agency and regulatory level. All the newly developed Shari’ah screening methodologies shared a common core i.e. screening out the Shari’ah non-compliant business activities e.g. alcohol, gambling. On the other hand, the threshold of the financial ratio was the distinguishing feature among the methodologies from applications of different juristic rulings. Even though Shari’ah stocks screening methodologies are a vital tool for Islamic equities sphere, there is a lack of empirical research on the Shari’ah governance dimension of the Shari’ah stocks screening methodologies. Therefore, understanding the degree of possibility of Shari’ah compliant stocks to become Shari’ah non-compliant will enhance the level of Shari’ah governance of the Shari’ah compliant stocks. The research aims to fill this gap by providing a Shari’ah governance tool for Shari’ah stocks screening methodologies, which will help Islamic investors and stakeholders to better understand the Shari’ah compliant stocks and the mechanisms of Shari’ah stocks screening methodologies around the world. The sample in this research includes 1440 Shari’ah compliant stocks spanning 69 countries with high market capitalization, over a period between 2010-2016/17. The sampled stocks were analyzed using the modified discriminate function to forecast the Shari’ah compliance level for the stock based on trends from historical Shari’ah compliance level of the stocks i.e. green, yellow and red. Forecast results provide the variations of Shari’ah compliance level of the stocks over the years for a robustness evaluation of 5 global Shari’ah stocks screening methodologies. The results highlight that the Standard & Poor and Dow Jones Shari’ah screening methodologies are more robust than others as they have a highest and stable number of green Shari’ah compliant stocks from the sample 1440 stocks from the year 2010 to 2016/17. The Shari’ah compliance trend from the historical data analysis can be further used to forecast the future Shari’ah compliance direction of the stocks.