Should the Malaysian islamic stock market investors invest in regional and international equity markets to gain portfolio diversification benefits?

Umairah, Fatin and Masih, Mansur (2017): Should the Malaysian islamic stock market investors invest in regional and international equity markets to gain portfolio diversification benefits?

Abstract

The paper asks the following questions: (i) What is the extent of the dynamic linkage of the conventional and Islamic stocks with the Malaysian Islamic stock market? (ii) Should the Malaysian Islamic stock market investors invest in (regional and international) conventional or Islamic equity market to gain international portfolio diversification benefits? (iii) How would the portfolio diversification benefits of the Malaysian Islamic investors change given different investor stock holding periods (e.g. 2-4 days, 4-8 days, 8-16 days, etc.)? The appropriate methods employed to addressing these questions are MGARCH-DCC and Continuous Wavelet Transformation (CWT). The data period covered is 2007 – 2017. The results tend to indicate that the FTSE Bursa Malaysia Hijrah Shariah Index has low correlation with the global stock market index, regardless of conventional or Islamic. However, the correlations in between the Islamic stock markets are quite high. Malaysian Islamic stock market investors who have allocated their investment in the global markets may enjoy portfolio diversification benefits. However, Malaysian Islamic stock market investors may not enjoy the real benefit if they allocate their funds in Dow Jones Islamic Asia Pacific Market but interestingly the medium-term investors may benefit from their investment. Also, the Malaysian Islamic stock market investors may lose if they invest in the conventional Malaysia Stocks Market (EMAS) as they may consist of the same stocks. Overall, the results tend to indicate that the Malaysian Islamic stock investors can reap the benefits of portfolio diversification in the regional and international equity markets if they take care of the extent of correlations between stocks at different investment horizons.

• Item Type: MPRA Paper
• Language: English
• Keywords: Stock market, Dynamic linkage, MGARCH, Wavelet Coherence, Malaysia, FTSE Hijrah Shariah Stock Index
• 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; G - Financial Economics > G1 - General Financial Markets > G11 - Portfolio Choice ; Investment Decisions; G - Financial Economics > G1 - General Financial Markets > G15 - International Financial Markets

References

Abdul Karim, B., Majid, A., Shabri, M., Karim, A. and Ariffin, S. (2009). Integration of stock markets between Indonesia and its major trading partners. Gadjah Mada International Journal of Business, 11(2), 1 -15.

Ajmi, A. N., Hammoudeh, S., Nguyen, D. K. and Sarafrazi, S. (2014). How strong are the causal relationships between Islamic stock markets and conventional financial systems? Evidence from linear and nonlinear tests. Journal of International Financial Markets, Institutions and Money, 28, 213-227.

Arshanapalli, B. and Doukas, J. (1993). International stock market linkages: evidence from the pre- and post-October 1987 period. Journal of Banking and Finance 17, 193–208.

Blackman, S.C., Holden, K. and Thomas, W.A. (1994). Long-term relationships between international share prices. Applied Financial Economics 4, 297–304.

Bollerslev, T. (1986), Generalized autoregressive conditional heteroskedasticity, Journal of Econometrics, vol. 31, 307-327

Bollerslev, T. (1990), Modeling the coherence in short-run nominal exchange rates: a multivariate generalized ARCH model, Review of Economic and Statistics, 72, 498–505.

Brocato, J. (1994), Evidence on adjustments in major national stock market linkages over the 1980s. Journal of Business Finance and Accounting 21, 643–667.

Cheung, Y.-L.and Mak, S. (1992), The international transmission of stock market fluctuations between the developed markets and the Asian-Pacific Markets. Applied Financial Economics 2, 43–47.

Chung, P.J.and Liu, D.J. (1994) Common stochastic trends in Pacific Rim stock markets. Quarterly Review of Economics and Finance 34, 241–259.

Click, R.W. and Plummer, M.G. (2005). Stock market integration in ASEAN after the Asian financial crisis, Journal of Asian Economics, 16, 5-28.

Corhay, A., Tourani Rad, A.and Urbain, J.-P (1995). Long run behaviour of Pacific-basin stock prices. Applied Financial Economics 5, 11–18.

Corsetti, G., Pesenti, P., and Roubini, N. (1998). What caused the Asian currency and financial crisis? Part I: A macroeconomic overview, Number w6833. National Bureau of Economic Research.

Daubechies, I. (1992), Ten Lectures on Wavelets, Volume 61 of CBMS-NSF Regional Conference Series in Applied Mathematics, Society for Industrial and Applied Mathematics, Philadelphia.

Engle, R. (1982), “Autoregressive conditional heteroskedasticity with estimates of the variance of UK inflation, Econometrica, 50, 987 -1008

Engle, R. (2002), “Dynamic conditional correlation: a simple class of multivariate generalized autoregressive conditional heteroskedasticity models”, Journal of Business and Economic Statistics, 20, 339–350.

Errunza, V. and Losq, E., (1985). International asset pricing under mild segmentation: theory and tests. Journal of Finance 40, 105–124.

Eun, C. and Shim, S. (1989). International transmission of stock market movements. Journal of Financial and Quantitative Analysis 24, 241–256.

Gencay, R., Selcuk, F. and Whitcher, B. (2001), “Differentiating intraday seasonalities through wavelet multi-scaling”, Physica A, 289, 543–556.

Gencay, R., Selcuk, F. and Whitcher, B. (2002). An Introduction to Wavelets and Other Filtering Methods in Finance and Economics. Academic Press, SanDiego: CA. / Goldstein, M., and Mussa, M. (1993). The integration of world capital markets. IMF Working Paper number 93/95, International Monetary Fund.

Gonzalo, J. (1994). Five alternative methods of estimating long run equilibrium relationships. Journal of Econometrics 60, 203–233.

Grubel, H. and Fadner, K. (1971), The interdependence of international equity markets, Journal of Finance, 26 (1), 89–94.

Grubel, H. G.(1968), Internationally Diversified Portfolios: Welfare Gains and Capital Flows, The American Economic Review, 58(5), 1299-1314.

Hafner, C.M. and Herwartz, H., (2009), Testing for linear vector autoregressive dynamics under multivariate generalized autoregressive heteroskedasticity. Statistica Neerlandica, 63 (3), 294–323.

Hiemstra, C. and Jones, J.D., (1994). Testing for linear and nonlinear Granger causality in the stock price-volume relation. Journal of Finance 49, 1639–1664.

Ibrahim, M.H. (2005). International Linkages of Stock Prices: The Case of Indonesia, Management Research News, 28(4), 93-115.

In, F. and Kim, S. (2013). An introduction to wavelet theory in finance. World Scientific Publishing: Singapore.

Jeon, B.N.and Von F., (1990). Growing international co-movement in stock price indexes. Quarterly Review of Economics and Business 30, 15–31.

Jorion, P. and Schwartz, E. (1986), “Integration versus segmentation in the Canadian stock market, Journal of Finance, 41, 603-616.

Kasa, K. (1992), Common stochastic trends in international stock markets. Journal of Monetary Economics 29, 95–124.

King, M. A. and Wadhwani, S., (1990), Transmission of Volatility between Stock Markets, Review of Financial Studies, 3(1), 5-33

Kwan, A.C.C., Sim, A.-B. and Cotsomitis, J.A. (1995). The causal relationships between equity indices on world exchanges. Applied Economics 27, 33–37.

Levy, H. and Sarnat, M., (1970). International Diversification of Investment Portfolios, The American Economic Review, 60(4), 668-675.

Ling, X. and Dhesi, G. (2010), Volatility spillover and time-varying conditional correlation between the European and US stock markets, Global Economy and Finance Journal, 3, 148–164.

Longin, F. and Solnik, B. (1995), Is the correlation in international equity returns constant: 1960–1990, Journal of International Money and Finance, 14, 3–26.

Longin, F. and Solnik, B. (2001),Extreme correlation of international equity markets, Journal of Finance, 56, 649–676.

MacKinnon, J.G. and White, H., 1985. Some heteroskedasticity consistent covariance matrix estimators with improved finite sample properties. Journal of Econometrics 29, 305–325.

Madaleno, M. and Pinto, C. (2012), International stock market indices comovements: A new look, International Journal of Finance and Economics, 17, 89 -102

Malliaris, A.G. and Urrutia, J.L. (1992). The international crash of October 1987: causality tests. Journal of Financial and Quantitative Analysis 27, 353–364.

Masih, R. and Masih, A. M. (2001), Long and Short Term Dynamic Causal Transmission Amongst International Stock Markets, Journal of International Money and Finance, 20, 563-587.

Mathur, I. and Subrahmanyam, V., 1990. Interdependencies among the Nordic and U.S. stock markets. Scandinavian Journal of Economics 92, 587–597.

Mishkin, FS. (2011). Over the Cliff: From the Subprime to the Global Financial Crisis, Journal of Economic Perspectives, 25(1), 49-70.

Moore, M.J. and Copeland, L.S. (1995) A comparison of Johansen and Phillips–Hansen cointegration tests of forward market efficiency: Baillie and Bollerslev revisited. Economics Letters 47, 131–135.

Percival, D. (1995),On the estimation of the wavelet variance, Biometrika, 82, 619–631.

Percival, D. and Walden, A. (2000). Wavelet Methods for Time Series Analysis. Cambridge University Press, New York

Phillips, P.C.B. (1991), Optimal inference in cointegrated systems, Econometrica, 59, 283–306

Saiti, B., Bacha, O. I. and Masih, M. (2016) Testing the Conventional and Islamic Financial Market Contagion: Evidence from Wavelet Analysis, Emerging Markets Finance and Trade, 52(8), 1832 -1849.

Saiti, B., Bacha, O. I., and Masih, M. (2013). Estimation of dynamic conditional correlations of Shariah-compliant stock indices through the application of multivariate GARCH approach, Australian Journal of Basic and Applied Sciences, 7(7), 259-267.

Smithi, K.L., Brocato, J. and Rogers, J.E. (1993), Regularities in the data between major equity markets: evidence from Granger causality tests. Applied Financial Economics 3, 55–60.

Solnik, B. (1991), International Investments. Addison-Wesley, New York.

Vacha, L and Barunik, J. (2012), “Comovement of Energy Commodities Revisited: Evidence from Wavelet Coherence Analysis”, Energy Economics, 34(1), 241 -247

Wheatley, S. (1988). Some tests of international equity integration. Journal of Financial economics, 21(2), 177-212.