Essays on Islamic finance and banking

Islamic banking and finance have received a considerable attention from academics and practitioners after the global financial crisis. Drawing insights from the theoretical and empirical studies about the resilience and the relative stability of Islamic financing alternatives - compared to their conventional peers- during turbulent economic and market conditions, I found that Islamic alternatives are not as less risky and stable as previously presented. This thesis makes a contribution to the asset management literature by examining whether Shari'ah compliant exchange traded funds (ETFs) have potential diversification benefits to a volatile portfolio of investments in emerging markets. The portfolio consists of three asset classes: conventional and fixed-income securities in emerging markets and Shari'ah compliant equity. I utilise a dynamic optimisation strategy to capture the time-variability in correlations between Islamic ETFs and other ETFs and find the optimal portfolios accord-ingly. I back test the results by using a static optimisation strategy and estimating optimal portfolios over two sample periods. The results are new to the literature, since previous empirical evidence is either comparing Islamic and conventional equity or Islamic and conventional bonds using static asset allocation strategies. Furthermore, this thesis contributes to the literature by taking a holistic approach and analyses the role of Islamic banks on both the micro and macro levels. I examine the effect of Islamic banks' financial distress on other financial institutions and the financial system in 10 Muslim majority countries. The research sample comprises 352 conventional and Islamic financial institutions. I do not consider only Islamic banks' specific characteristics and macroeconomic variables, but I also take in consideration the financial linkages and the spillover effects of financial institutions' distress. This research is pivotal, because it fills a research gap when it comes to identifying the systemic relevance and role of Islamic banks in financial systems. Previous research has adopted a top down approach and has identified the effect of the system on Islamic banks. Given the liter-ature about increasing business risks in the Islamic banking sector, I hypothesise that Islamic banks contribute to systemic risk. In addition, I identify whether the effect of Islamic banks' distress on the system is due to the change in their business risks over time. The findings of this thesis are new to the literature and provide implications of great importance. Institutional investors should consider the religion effect when they manage their assets, given the evidence regarding the outperformance of Shari'ah compliant equity relative to their conventional peers. They should also be cautious when using dynamic strategies, because they can be more costly to apply specially in volatile markets such as emerging markets and during crisis periods. For central banks and regulator, they should consider Islamic banks as genetically modified conventional banks). If Islamic banks and financial authorities did not address the routes of inefficiency, insolvency risk, and withdrawal risk in Islamic banks, they will continue to contribute to financial systems' distress.