Bounded Rationality Under Sharia Norms: Evidence from Indonesia

Abstract

In Indonesia, the application of Islamic norms in finance, commonly referred to as sharia finance, has recently begun to be studied from a behavioral economics perspective, especially under the hypothesis of agency problems and bounded rationality. By clustering, profiling, and portfolio analysis using data released by the Financial Services Authority (FSA) regarding sharia banking, and by Indonesia Stock Exchange (IDX) regarding sharia securities in the Indonesian capital market, this study aims to 1) identify the impact of moral restrictions in the form of sharia compliance, 2) evaluate the existence of agency problems in sharia financing, and 3) bounded rationality in portfolio investment that conforms with sharia compliance. Analysis using data from sharia finance in Indonesia indicate a bounded financing decision but does not indicate a significant agency problem, especially in profit-loss sharing financing; there are only insignificant signs. Meanwhile, the hypothesis of bounded rationality in Islamic investment portfolios is significantly proven. Sharia compliance can reduce portfolio risk but it also reduces its rate of return; and vice versa, a reduction in the level of compliance within the allowed limits can increase the rate of portfolio return but it is accompanied by an increase in risk. Keywords—Bounded rationality, Financing, Portfolio Investment, Sharia Compliance