Numerical Comparison of Risk Distribution in Conventional and Islamic Instruments in Project Finance

Abstract

The adoption of Islamic instruments in project finance shows growing trends and potential for the future. Several studies state that the underlying philosophy of Islamic finance is risk-sharing, as opposed to the risk-trading concept of conventional finance. This article investigates the effect of conventional and Islamic financial instruments on the risk-return relationship of the project parties and assesses whether the risk-sharing philosophy of Islamic finance can be numerically identified. The study uses Monte Carlo simulations and different risk measures to assess the influence of several financing parameters.

The method is applied to the Sydney Cross City Tunnel project, where the financing structure of the project is replicated with conventional and Islamic instruments. The investigation confirms that the adoption of Islamic instruments leads to a risk-return redistribution among the project parties and explains how conventional, Istisna, and Mudarabah instruments produce different risk-return profiles.