Leverage, Sensitivity to Market Risk and Contagion: A Multi-Country Analysis for Shari’ah(Islamic) Stock Screening

el Alaoui, AbdelKader and Masih, Mansur and Bacha, Obiyathulla and Asutay, Mehmet (2014): Leverage, Sensitivity to Market Risk and Contagion: A Multi-Country Analysis for Shari’ah(Islamic) Stock Screening.

Abstract

This study is the first attempt to investigate the relationship between firm’s leverage and systematic risk for seven European countries in relation to Shari’ah (Islamic) stock screening. This paper also aims to examine the shock transmission through the systematic risk and whether less debt could bring more stability to the capital market. Using a dynamic panel technique based on VAR (Vector autoregressive) and dynamic GMM framework, we analyse the levered and the unlevered beta of the firm based on the firm characteristics before adding the country characteristic effects in order to take into account the heterogeneity across firms, which ensures the robustness of the results. We find that leverage is significantly and positively associated with systematic risk and that high leverage augments systematic risk, which is more affected by the nature of the European market rather than the firm characteristic effect. However, the existence of high leverage is indicative of having a big role in making worse the firm conditions under shocks. The presence of these effects is further explored through the responses of the model’s variables to market-wide volatility and shocks. Finally, the sensitivity to the market appears to be impacted by the financial crisis in terms of contagion in leverage with implications for portfolio diversification. Our findings have implications on the stability of firm’s risk exposure and the appropriate level of debt’s commitment to be made by managers.

• Item Type: MPRA Paper
• Language: English
• Keywords: sensitivity to the market or systematic risk, leverage, dynamic GMM panel technique, financial crisis, contagion, Shari’ah stock screening
• Subjects: C - Mathematical and Quantitative Methods > C2 - Single Equation Models ; Single Variables > C22 - Time-Series Models ; Dynamic Quantile Regressions ; Dynamic Treatment Effect Models ; Diffusion Processes; C - Mathematical and Quantitative Methods > C5 - Econometric Modeling > C58 - Financial Econometrics; E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E44 - Financial Markets and the Macroeconomy; G - Financial Economics > G1 - General Financial Markets > G15 - International Financial Markets

References

Bae, K., Karolyi, G. And Stulz, R., 2003. A new approach to measuring financial contagion. Rev. Financial Stud. v16. 716-763.

Billio M. & Caporin M. 2010. “Market linkages, variance spillovers, and correlation stability: Empirical evidence of financial contagion”, Computational Statistics & Data Analysis, v.54 n.11, p.2443-2458, November, 2010 [doi>10.1016/j.csda.2009.03.018]

Bodart, V. and Candelon, B., 2009. Evidences of interdependence and contagion using a frequency domain framework. Emerg. Mark. Rev. v10. 140-150.

Cashin, P., Kumar, M.S., and McDermott, C.J., 1995. International integration of equity markets and contagion effects. IMF Working Papers No. 95/110.

Chou, R.Y.-T., Ng, V., and Pi, L.K., 1994. Cointegration of international stock market indices. IMF Working Papers No. 94/94.

Conine, T., 1983. “On the Theoretical Relationship Between Systematic Risk and Price Elasticity of Demand,” Journal of Business Finance and Accounting, Summer 1983.

Corsetti, G., Pericoli, M., and Sbracia, M., 2001. Correlation analysis of financial contagion: what one should know before running a test. Banca d I talia Temi di Discussione No. 408

Corsetti, G., Pericoli, M., and Sbracia, M., 2005. Some contagion, some interdependence: more pitfalls in tests of financial contagion. J. Int. Money Fin. v24. 1177-1199.

Costinot, A., Roncalli, T., Teletche, J., 2000. Revisiting the dependence between financial markets with copulas. Working Paper Credit Lyonnais.

Daubechies, 1992. In: CBSM-NSF Regional Conference Series in Applied Mathematics, SIAM, Philadelphia.

Dornbusch, R., Park, Y., and Claessens, S., 2000. Contagion: understanding how it spreads. World Bank Res. Obs. v15. 177-197.

Dungey M. and Tambakis D. N., (2003). "International Financial Contagion: What Do We Know?", - WORKING PAPER NO 9 - July 2003

Eichengreen, B., Rose, A., and Wyplosz, C.,1996. Contagious currency crises: first tests. Scand. J. Statist. v98. 463-484.

Engsted, T., and Tanggaard, C., 2004. The comovement of US and UK stock markets. European Financ. Manage. v10. 593-607.

Fernandez, P., 2006. Levered and unlevered beta. Working paper. IESE Business School - Univesidad de Navara – 2003 and revised in 2006.

Fernandez, P., 2004. The value of tax shields is NOT equal to the present value of tax shields. Journal of Financial Economics.

Gallo,G., and Otranto, E., 2008. Volatility spillovers, interdependence and comovements: A Markov Switching approach, Computational Statistics & Data Analysis, v.52 n.6, p.3011-3026, February, 2008 [doi > 10.1016 / j.csda.2007.09.016]

Gencay, R., Selcuk, F., and Whitcher, B., 2001. Scaling properties of exchange rate volatilities. Physica A. v289. 89-106.

Gencay, R., Selcuk, F., and Whitcher, B., 2002. An Introduction to Wavelets and Other Filtering Methods in Finance and Economics. San Diego Academic Press, San Diego.

Gencay, R., Selcuk, F., and Whitcher, B., 2005. Multiscaling systematic risk. J. Int. Money Financ. v24. 55-70.

Hamada, R.S., 1972. Effect of firms capital structure on systematic risk of common stocks. Journal of Finance 27, 435–452.

Hamao, Y., Masulis, R., and Ng, V., 1990. Correlations in price changes and volatility across international stock markets. Rev. Financial Stud. v3. 281-307.

Hochreiter M., E. (Eds.). “Private Capital Flows to Emerging Markets After the Mexican Crisis”, Institute for International Economics, Washington, DC.

King, M. and Wadhwani, S., 1990. Transmission of volatility between stock markets. Rev. Financial Stud. v3. 5-33.

Lee, S., and Kim, K., 1993. Does the October 1987 crash strengthen the comovements among national stock markets?. Rev. Financial Econom. v3. 89-102.

Longin, F. and Solnik, B., 1995. Is the correlation in international equity returns constant: 1960-1990?. J. Int. Money Finance. v14. 3-26.

Orlov, A., 2009. Co-spectral analysis of exchange rate comovements during Asian financial crisis. J. Int. Financ. Mark. Inst. Money. v19. 742-758.

Percival, D. and Walden, A., 2000. Wavelet Methods for Time Series Analysis. Cambridge University Press, Cambridge, UK.

Whitcher, B., 2000. Wavelet analysis of covariance with application to atmospheric time series. J. Geophys. Res. Atmosph. v105. 14941-14962.