The effect of Islamic financial risk products on market risk management: A comparative analysis of traditional and Islamic index shares

The demand for Islamic financial products has shown remarkable developments in recent decades. Although their share is still relatively small compared to that of the traditional financial products, it has grown rapidly and these products have a promising future. Islamic financial products are expected to play an important role in the financial industry and contribute to the economy in general in the future. This study examines the problem of the non-conformity of many financial engineering products in the management of the market risk with the Islamic rules in financial transactions and proposes a solution to this problem with portfolio insurance. The study contributes to the literature as the use of these tools for market risk has not been studied in Islamic finance. This study investigates the effect of portfolio insurance techniques using fixed income instruments on the performance of Islamic stock portfolios. To achieve this goal, the portfolios of Shariah-compliant and Shariah non-compliant stocks were created using the daily closing prices from the Malaysian Stock Exchange during the period 2015-2020. The performance of the option-based portfolio insurance OBPI and the constant proportion portfolio insurance strategies were compared by using three levels of volatility (high, medium, and low volatility). The results of the study demonstrate the importance of using both option-based portfolio insurance (OBPI) and constant proportion portfolio insurance (CPPI) strategies in protecting Islamic portfolios from market risk. Keywords: Financial Engineering, Islamic Finance, option-based portfolio insurance OBPI, Market Risk, constant proportion portfolio insurance CPPI.