How strong are the causal relationships between Islamic stock markets and conventional financial systems? Evidence from linear and nonlinear tests

Abstract

Past studies suggest that the Islamic …nance system is only weakly linked or even decoupled from conventional markets. If this statement is true, then this system may provide a cushion against potential losses resulting from probable future …nancial crises. In this article, we make use of heteroscedasticity-robust linear Granger causality and nonlinear Granger causality tests to examine the links between the Islamic and global conventional stock markets, and between the Islamic stock market and several global economic and …nancial shocks. Our …ndings reveal evidence of signi…cant linear and nonlinear causality between the Islamic and conventional stock markets but more strongly from the Islamic stock market to the other markets. They also show potent causality between the Islamic stock market and …nancial and risk factors. This evidence leads to the rejection of the hypothesis of decoupling of the Islamic market from their conventional counterparts, thereby reduces the portfolio bene…ts from diversi…cation with Sharia-based markets. A striking result shows a connection between the Islamic stock market and interest rates and interestbearing securities, which is inconsistent with the Sharia rules. The results also suggest that modeling Islamic stock markets should be done within a nonlinear VAR system and not through a regression equation.

Risk transmission between Islamic and conventional stock markets: A return and volatility spillover analysis

“…Therefore, our findings can be interpreted as sound evidence against the empirical validity of the decoupling hypothesis of the Islamic global stock market from its mainstream counterparts. In addition, it is worth mentioning that the results of our study, in favour of the rejection of the decoupling hypothesis, are consistent with those from several recent contributions, such as Ajmi et al (2014), Dewandaru et al (2015), and Nazlioglu et al (2015), based on the application of a variety of methodological approaches on different countries and sectors.…”

“…Thus, Islamic equity investments may provide investors significant diversification benefits and play a safe haven role during episodes of financial stress. In this context, Ajmi et al (2014) identify significant linear and nonlinear Granger causality relationships among the global Islamic stock market, the conventional stock markets for the U.S., Europe and Asia, and several global economic and financial shocks. Using a copula approach, Hammoudeh et al (2014) find significant time-varying dependence among the global Islamic stock market index, three major global conventional stock indices from the U.S., Asia and…”

Issues in Islamic banking and finance: Islamic banks, Shari’ah-compliant investment and sukuk

“…In contrast, recent studies by Hammoudeh et al (2014), Dewandaru et al (2014), Ajmi et al (2014), Yilmaz et al (2015) and Rizvi et al (2015) negate the decoupling hypothesis. Using a copula approach, Hammoudeh et al (2014) demonstrate the significant dependence of the global Islamic equity market index on major global conventional equity indexes and various global factors, highlighting no distinct differences of the Islamic indexes from the conventional indexes.…”

Cross-sectoral interactions in Islamic equity markets

“…all the components are traded indiscriminately, regardless of their true value and/or firm fundamentals, yielding to a severe increase in correlations even between the different Islamic equity sectors. 15 For example, see Ajmi et al (2014) for evidence of non-linear causal relationship between Islamic and conventional markets. Moreover, a recent study by Hammoudeh et al (2014) Moreover, this effect is emphasized further through financial contagion channels in the recent global financial crisis.…”