Asset pricing anomalies: The case of dividends in the US for Sharia-compliant firms

Abstract

This paper investigates asset pricing anomalies in sharia-compliant (SC) stocks in the US market, focusing on whether dividend-oriented strategies can yield significant alphas. SC stocks adhere to Islamic principles, avoiding activities such as the production and sale of alcoholic beverages, gambling, and using interest-based financial services. Despite growing interest in ethical investments, the specific asset pricing dynamics of SC stocks in the US are underexplored. This paper investigates the research question of whether investors in SC stocks in the US can earn significant and consistent alphas by adopting dividend-oriented strategies. The objective is to study the presence of significant intercepts in 25 size-dividend portfolios using various asset pricing models, including the capital asset pricing model (CAPM), the Fama & French 3-Factor Model (FF3), Fama & French 5-Factor Model (FF5), and Fama & French 6-Factor Model (FF6), over the period from 1993 to 2023. The data includes all stocks listed on the New York Stock Exchange (NYSE), AMEX, and NASDAQ, screened for sharia compliance. Our methodology involves sorting SC stocks into 25 portfolios based on size and dividend characteristics (dividend yield, change in dividend yield, and change in absolute dividends). Our findings indicate that whereas most portfolios do not show significant alphas, a small number do, particularly for larger firms. The CAPM is sufficient for explaining average excess returns for most portfolios, with additional factors providing marginal improvements. Our robustness checks include comparing local factors to FF factors to show that local factors have higher explanatory power but more significant intercepts and vice versa. Practically, the paper suggests that although dividend-oriented strategies may not yield significant alphas for most SC stocks, there are exceptions, especially for larger firms. This highlights the potential for earning higher returns through careful selection of dividend-paying SC stocks. At the same time, our findings simplify the process of estimating required returns and managing investment risks for SC stocks.