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Do changes in shariah screening methodology make islamic indices substitutes or complements? an application of MGARCH-DCC and markov switching analysis.

Mantai, Mohammed Mahmoud and Masih, Mansur (2016): Do changes in shariah screening methodology make islamic indices substitutes or complements? an application of MGARCH-DCC and markov switching analysis.

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Abstract

Many studies have examined the portfolio diversification opportunity of the Shariah compliant indices returns and markets including Malaysia. For the case of Malaysia, most of the recent studies have found lesser possibilities of diversification due to the trading partnerships and regional market contingencies. However, in this study, we apply MGARCH-DCC and use the MS-AR technique, for the first time to the best of our knowledge, to investigate the impact of the newly introduced Shariah screening methodology taking the Malaysian shariah FTEM index as a case study together with other 5 Islamic indices to assess the extent of portfolio diversification particularly after the new change as well as to identify the periods of stable and high volatilities. The findings of this study are consistent with the recent findings of (Najeeb et.al (2015); Rahim and Masih (2016)) with regards to portfolio diversification despite recent changes in the Shariah screening methodology. Nonetheless, with regards to the regime change and the probability duration of FTEM, we found that the shift from the stable to volatile regime normally takes place after 9 weeks with the probability of staying in each regime 66 and 75 weeks respectively. Therefore, the new screening methodology has yet to shift Islamic indices from being a substitute to a complement. Finally, the findings of this paper may provide some insights to both Islamic equity investors and policy makers of the Islamic finance industry.

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