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Portfolio Diversification Benefits of Islamic Stocks and Malaysia’s Major Trading Partners:MGARCH-DCC and Wavelet Correlation Approaches

Rahim, Adam Mohamed and Masih, Mansur (2014): Portfolio Diversification Benefits of Islamic Stocks and Malaysia’s Major Trading Partners:MGARCH-DCC and Wavelet Correlation Approaches.

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Abstract

Previous studies have investigated the interdependence of Malaysian stock market with its major trading partners without taking into account the time-varying correlations and different investment horizons of the investors. The main objective of this paper is to study the extent to which the Malaysian Shari’ah (Islamic) investors can benefit from portfolio diversification with the Shari’ah indices of its major trading partners (China, Singapore, Japan, United States and Thailand). The recent Multivariate GARCH Dynamic Conditional Correlation, the Continuous Wavelet Transform and the Maximal Overlap Discrete Wavelet Transform are applied. Findings tend to indicate that the Malaysian Shari’ah investors who have allocated their investments in major trading partners like China and Singapore may not reap great diversification benefits for almost all investment horizons but may reap moderate benefits arising from Thailand and Japan up to the investment horizons of 32-64 days and longer. The evidence suggests that the portfolio diversification benefits are greater if the Malaysian Shari’ah investors invest in the US Shari’ah stock index excepting the long investment horizons. The stock holding periods exceeding 32 to 64 days contain minimal benefits of portfolio diversification. As an implication, the Malaysian Shari’ah investors should carry out the reassessment of their stock exposures and investment horizons more frequently.

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