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Long run asymmetric relationships between Islamic and conventional equity indices

Research output: Working paper

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Abstract

Despite the substantial growth in the Islamic finance sector in the recent years, there has been limited empirical research on Islamic equity indices. In our paper we explore the interconnectedness between Islamic and conventional equity indices during the period spanning from 2006 to 2010. The Dow Jones Islamic Market is representative of the Islamic equity market, while the Dow Jones Global and Dow Jones Industrial Average are well perceived equity benchmark indices. We adopt hidden co-integration and granger causality analysis, while we examine the impact of market conditions. We find that the negative index components are significant between the Islamic equity index and the conventional benchmarks, yet the two conventional indices do not support this contention. Moreover, there is evidence that an increasing in magnitude driving force emanates from the Islamic to the conventional index in the crisis and post-crisis periods. A portfolio optimisation case study reveals that there are diversification benefits to be reaped by the inclusion of an Islamic equity index. The finding is tied to the Islamic index’s performance and diversification benefits, particularly during the financial crisis. It may be further linked to investors’ embracing of Islamic finance principles on lower leverage and speculation practices.