Is the Long Term Profit Rate of Malaysian Sukuk a Good Predictor of Short Term Profit Rate?

Abstract

Decomposition of yield curves is important for pricing of fixed income instruments, inflation management, and modeling term structure of interest rates. Therefore, this study investigates whether the long term profit rate of different classes of Sukuk (Islamic Bond) is a viable predictor of future spot profit rates. Data on Malaysian Sukuk from 2001-2010 was used to estimate yield curves and forward rates. Regression findings suggest that the forward rate is a weak predictor of future spot profit rate, implying long term profit rates are not the average of future spot rates on long term Sukuk. The findings 
do not support the expectation hypothesis. However, comparison with securities of the same default risk, but with different maturities, reveals the presence of an in-built support for term premium in the yield curves of corporate Sukuk. This finding is consistent with the Liquidity Preference Theory. We also find further support for Market Segmentation Theory as we find a humped shaped yield curve in the Sukuk market.