An optimal Islamic investment decision in two-region economy: The case of Indonesia and Malaysia

Abstract

In this work, the possibility of cross-border activities between two regions in the framework of the investment contract is viewed as optimal allocation problems. The problems of determining the optimal proportion of funds to be invested in liquidity and technology are analyzed in two different environments. In the first case, we consider a two-region and two-technology economy in which both regions possess the same productive technology or project, but a different stream of return. While in the second case, we examine an economy where two regions (i.e., Indonesia and Malaysia) hold different Islamic productive projects with identical returns. Allocation models are formulated in terms of investors’ expected utility maximization problem under budget constraints with respect to regional and sectoral shocks. It is revealed that optimal parameters for liquidity ratio, technological investment profile, and bank repayment are analytically characterized by the return of a more productive project and the proportion of impatient and patient investors in the region. Even though both cases employ different assumptions, they provide the same expressions of optimal parameters. The model suggests that cross-border Islamic investment activities between two regions might be realized, provided both regions hold productive projects with an identical stream of return. This paper also shows that by increasing the lower return of the project approaching the higher return, a room for inter-region investment can be created. An analytical framework of an investment contract in terms of optimal allocation model is provided.