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The Dynamic Linkages between Islamic Index and the Major Stock Markets: New Evidence from Wavelet time-scale decomposition Analysis

Abu Bakar, Norhidayah and Masih, Abul Mansur M. (2014): The Dynamic Linkages between Islamic Index and the Major Stock Markets: New Evidence from Wavelet time-scale decomposition Analysis.

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Abstract

The increase of globalization and financial liberalization along with the recurrence of the financial crises have made the issue of global stock market integration crucial particularly from the view of portfolio diversification. Moreover, an empirical time-scale-varying analysis from the perspective of Islamic stock is still lacking. The Islamic stocks are expected to be theoretically different from the conventional stocks in view of the Shariah-compliant restrictions, smaller and less diversified market. Therefore, this paper makes the first attempt to test the time-scale analysis of the linkages between the international Islamic stock index and six major international stock markets such as, the United States, United Kingdom, Europe, Japan, China, and Malaysia. The paper analyzes the cross volatility, comovement, and estimates the Granger causality between the stock markets using the recently applied continuous wavelet transform and maximal overlap discrete wavelet transform. The findings tend to suggest strong linkage between Islamic index and the western markets as compared to the Asian markets. The volatility and comovements between stock indices are higher and unstable during the financial crises. Furthermore, the results indicate the existence of inefficient market, spillover effect of financial crisis, strong causality effects and bi-directional causality between Islamic index and other international indices. As for the policy implications, the international investors should include the Asian market in their investment portfolio, however, the instability and high comovement especially during the crises will limit the investors‟ ability to exploit international diversification. Additionally, the inefficient markets might suggest an arbitrage opportunity for the investors.

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