A comparison of Islamic vs conventional indices: A Wavelet based approach

Nowadays Islamic Finance and Islamic Investment Instruments are becoming more and more popular and show a significant increase in volumes. Due to this trend, stating from 1970s significant momentum has been spotted in the academic studies, especially in the ones that compare Islamic Investments to their conventional counterparts. An important motivation behind this increase is the search and test for differences offered to investors by these Islamic alternatives which included Sharia based rules and measures. To be more precise these studies mostly tested for any impact of these Shariah measures on the volatility and returns patterns of the investors either on the negative side (creating excess loss) or on the positive side (increasing profits or creating a safer investment alternative) Studies based on the Islamic Indices are inseparable pieces of these studies. Recent years have opened a new perspective in this research area where some of the academic literature focused on a newer model which is the Wavelet Approach. While wavelets are not new to the academic world as they are utilized in several other areas (Math, Physics etc.…) they are mostly new to the finance literature. This study tries to compare Islamic Indices and tries to figure out possible linkage between same country indices in terms of a Wavelet Approach which helps us to figure out the return patterns and dynamics to forecast volatility and thus estimate price movements. Our empirical results suggested almost non or very little opportunity for portfolio diversification or a presence for protection between conventional and Islamic indices as the coherence results were high. The power spectrum and correlation patterns showed very high scale wise correlation in lower trading frequencies whereas at longer terms decreasing but again high correlation was present. However, the results indicated that in countries where the financial sector equities play a dominant role such as Turkey, Italy, and Spain there may be an opportunity to diversify the portfolios with Islamic index stocks as the leverage factor in the financial stocks is eliminated by the screening element in Islamic Index Construction. Further research, extending the data to region level and diversifying the underlying assets with other Islamic instruments such as fixed income Sukuks would be useful in the field.