Purpose
Upper bound on Sharpe ratio helps to evaluate the risk-adjusted performance in real market setting. The purpose of this study is to evaluate the performance of Shariah-compliant indices (SCIs) and also estimate the upper bound on Sharpe ratio in real-market setting. For comparison, the authors also report the same statistics for conventional indices (CIs).
Design/methodology/approach
This study considers returns of 12 indices from Asia-Pacific and the USA for the time period May 31, 2013-Aug 25, 2022. These indices are further classified as small-, mid- and large-cap indices. The upper bound is estimated in three settings, an unconstrained setting, correlation constraint and copula constraint.
Findings
The authors found that upper bound estimation is sensitive to both the choice of index, geographic location and size of constituents within the index. Interestingly, SCIs outperform CIs both in terms of Sharpe ratio and upper bound estimations. The ability of SCIs to achieve high Sharpe ratio boosts investors’ confidence. The results are robust even after introducing correlation and copula constraints to the model.
Practical implications
Any violation of the upper bound on Sharpe ratio is not necessarily an indication of fraud or dubious Sharpe ratio. It should be interpreted only as a signal for inflated risk-adjusted performance and requires further investigation. Together with risk-adjusted performance, fund managers should report upper bounds to insure investor protection.
Originality/value
Many studies have compared the risk-adjusted performance of SCIs and CI. To the best of the authors’ knowledge, this study is the first effort to evaluate and compare the upper bounds on Sharpe ratio of SCIs in a real-market setting.
