In this paper, we adapt Barreda-Tarrazona et al.’s (2011) design<sup>10</sup> to shed light on motives behind Islamic investing. We find that religious preferences are an important driver of investment in Islamic mutual funds. The evidence for this comes from an incentivized lab experiment conducted with a majority Muslim student sample (at a university in Pakistan, a Muslim majority country). Our use of the lab allows us to perfectly control financial metrics of Islamic and nonIslamic funds, allowing us to isolate the role of religiosity in Islamic investing and responsiveness to differences in performance and risk.

We fill a gap in the literature by providing evidence of an express linkage between religious preferences (as measured by an incentivized dictator game) and religiously motivated investments. We use the lab to measure behavior in a situation where subjects split their investment between pairs of funds: a “traditional” mutual fund that generates profits for the investor, and an “Islamic” fund, identical in every way except for the label, and a small (1% of profits) matched donation<sup>11</sup> to an Islamic institute (a local mosque) – simulating targeted benefits generated from investing. Subjects make multiple decisions, which vary returns and risk for one of the two funds, simulating the trade-off between fund performance and fund mission. This approach simulates investment behavior and allows us to identify the role of risk and religious preferences in Islamic investment decisions. Our lab experiment overcomes identification issues by focusing on paired choices between these two types of mutual funds. In addition to these, we further introduce a third, socially responsible, mutual fund which operates the same way as the Islamic fund but generates a small donation to a local charity (The Citizens Foundation).<sup>12</sup> The main experiment consists of a baseline and two treatments: In the baseline, subjects are introduced to two types of (traditional) mutual funds. Subjects are provided with a 5,000 token investment (worth 4,166 PKR, 40 USD) and are asked to make a series of investment decisions. Subjects choose how to split the investment between the two mutual funds. The first treatment varies the label on one of the traditional funds (labelled “Islamic” to provide subjects the right context), and adds a small, matched donation: 1% of the profits earned by the subject are matched by the experimenters and donated to the local mosque.<sup>13</sup> The second treatment connects to the literature on socially responsible investing, by replacing the Islamic charity (the local mosque) with a non-secular charity. Our subjects are students at the Lahore University of Management Sciences (LUMS) in Lahore, Pakistan, a higher education institution. To measure religious and social preferences, we use modified dictator games with charity recipients. We measure risk preferences using hypothetical choices between a sure payment and a 50-50 gamble, with decisions varying the amount of the sure payment (see Charness et al., 2013 for an excellent review on eliciting risk preferences).

We find that investment in the Islamic fund is driven by religious preferences, with investors willing to take greater reductions in returns (and increases in risk) for the sake of investing in funds that align with their beliefs. We do not find evidence that religious investors are in general less sensitive to financial performance when investing in conventional funds. Further treatments implement a socially responsible fund (a la Barreda-Tarrazona et al., 2011), and find a similar

> 10 Unlike their setup, we do not use real mutual funds to generate one of our decisions, but implement a lab version of mutual funds, which allows us to directly control fund parameters (risk and returns).  In this manner, we are able to exert greater control over the decision environment, though we cannot claim the realism that they implement in their experiment.

> 11 Importantly, the donation is matched by the experimenters, such that the actual profits to the subject from the traditional and Islamic funds are identical. The instructions make this feature clear to the subjects so as to avoid any confusion.

> 12 For more information about the foundation, please see: https://www.tcf.org.pk/.

> 13 The donation does not affect subject earnings any differently to that in the baseline. Hence, differences in investment between treatment and control can be directly attributed to the usage of the Islamic fund.