Why do sukuks (Islamic bonds) need a different pricing model?

Abstract

Abstract The global interest in sukuk, an Islamic alternative to bond financing, has grown rapidly, particularly after the 2008 global financial crisis, due to its distinctive features and investment quality. Sukuk were first launched in Malaysia and are presently available in 29 countries, including the United Kingdom, United States, Singapore, Hong Kong, and Luxembourg. Despite the global market prevalence of sukuk, asset pricing literature has not yet addressed the pricing mechanism of sukuk, which is inherently different from bonds and equity due to the contractual differences. However, analysts use LIBOR, or the Islamic interbank benchmark rate, as the ad‐hoc benchmark to evaluate sukuk performance. In this study, we develop a basic pricing model that captures the common risks in sukuk returns. We identify two risk factors for sukuk that require risk premiums: (a) sukuk market risk and (b) information asymmetry risk. Using these two common sukuk risks factors, investment analysts can estimate the fair value of sukuk more precisely than other ad hoc measures available.

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