The Currency Exposure and Syariah Compliant Status under Different Time Domains: Insights from Maximal Overlap Discrete Wavelet Transformation (MODWT) Analysis

Abstract

The rise of the Islamic capital market in the emerging economy of Malaysia over the past few decades motivates us to investigate the impact of the Syariah compliant status on the level of exchange rate exposure. The Syariah compliant status implies that a company should use a minimal level of debt as capital to finance its operations. Given this, it is hypothesized that Syariah compliant firms should exhibit lower levels of exchange rate exposure than their counterparts, supported by the strong theoretical connection between interest rate and exchange rate. In terms of specification, previous efforts in pricing exchange risk failed to capture the true size of exposure due to the use of single time domain in traditional model. To cater the bias in estimation, this study intends to calculate multi-horizon exchange rate exposure based on maximal overlap discrete wavelet transformation to decompose single series into multiple time domains. The financial risk analysis involves 30 listed non-financial individual stocks in Malaysia having different Syariah compliant status from November 2013 until May 2018. As a result, the study finds no significant difference in currency exposure between Syariah compliant and non-Syariah compliant stocks. Secondly, it is found that the extent of currency exposure and the percentage of exposed firms exhibit non-homogenous trend across different time scales where large amount of exposure is concentrated at higher scale. From policy implications, the study suggests that Syariah compliant firms and non-Syariah compliant firms share the same exchange risk profile where exchange risk management routine is expected to be identical for both groups. Besides, the enhanced level of exposure at higher scale requires vigorous financial risk hedging strategies especially within widened investment interval.