Capital Asset Pricing Model and Shariah-Compliant Capital Asset Pricing Model: Evidence from Pakistan Stock Exchange

: The key objective of this study is to recommend a novel approach in pricing Shariah based financial assets by testing Shariah-Compliant Capital Asset Pricing Models which can potentially replace the conventional CAPM in PSX. Using eighteen years extracted data from Thomson Reuters Data Stream over the period of January 2001 to December 2018 and by deploying Generalized Method of Moments (GMM), this study develops and analyses Shariah-Compliant Capital Asset Pricing Model. The returns of the stocks traded on PSX are calculated through the CAPM equation with Risk-Free Rate, without Risk-Free Rate, Zakat, NGDP and Inflation. The impact of size anomaly is also gauged in the study. The findings are surprising and specify that the Shariah CAPM can be the alternate of the conventional CAPM. The results of this study may show a new way to the investors, corporates and banks to calculate the required rate of returns of their securities. and Dar (2011) conducted another investigation on the listed stocks of the Pakistan Stock exchange. The researcher made 10 equally weighted portfolios comprising of a total of 100 stocks. The research was done by extracting the data of 9 years and the model was run on conventional CAPM and Shariah-compliant asset pricing model. The portfolios formed were based on the market capitalization of the stocks. The results of this study indicate that no portfolio has shown the statistically significant relationship; neither higher capitalization nor lower capitalization portfolio. The portfolios which gave statistically significant results were the medium-sized portfolios. The results of the medium-sized portfolios are better in model with Inflation as compared to the conventional CAPM. This shows that medium portfolios project better results when the risk-free rate is being replaced by inflation. Notably, the researchers have used two proxies of inflation 1. WPI and 2. CPI. The conclusion of the overall study indicates that the CAPM used in Pakistan Stock Exchange gives misleading based models are better than the conventional asset pricing model and CAPM without risk-free rate. The first row is the conventional CAPM which is the most used model for calculating the required rate of returns on the assets. The second row is of the CAPM without Rf was also proposed in the previous studies the results of these models are more or less the same as conventional CAPM. Evidently, the alpha values of all the Shariah models are better than the conventional models. The model where the zakat rate has replaced the risk-free rate is more lucrative both in P1 and P10 because of the existence of the size anomaly in the portfolios. Besides, the figures of the chi-Square (Wald Test) are vividly showing the variance amongst the portfolios. The chi-square test shows the cross-sectional variance in the returns of the portfolios as the P values of the portfolios is less than 0.010. This chi-square test applies to all models because of the value which is less than 0.010. It shows the cross-sectional variance amongst the portfolios. The conclusion of the equally weighted returns is statistically significant for the CAPM, CAPM without Rf, and all the Shariah version of CAPMs. The findings empirically show that the Shariah based capital asset models can be used to price the securities in a shariah-compliant way. P10 (large firm portfolios) shows negative alpha values, whereas the model in which zakat has replaced the risk-free rate is supersedes the alpha number. This study supports the shariah based models of calculating the returns on assets.