A Market Efficiency Comparison of Islamic and Non-Islamic Stock Indices

ABSTRACT

This article examines the martingale difference hypothesis (MDH) and the random walk hypothesis (RWH) for nine conventional and nine Islamic stock indices: Asia-Pacific, Canadian, Developed Country, Emerging, European, Global, Japanese, UK, and United States. It investigates whether Islamic stock indices are more, less, or as efficient as their conventional counterparts. We test four sub-periods of bullish and bearish stock markets, together with the financial meltdown and its recovery, over the period 1997–2012. We use the Escanciano and Lobato’s (2009) automatic portmanteau test (AQ) and Deo’s (2000) test for the MDH. We also apply the automatic variance ratio test (AVR) developed by Choi (1999) and Kim (2009) for the RWH. Over the period from 1997 to 2012, we find that three conventional indices (Europe, Japan, and UK) are efficient, but that none of the Islamic indices are efficient in these markets. During the recent financial crisis, our results indicate slightly more efficiency for the Islamic indices than their conventional counterparts. Our study finds that overall the conventional indices are more efficient than their Islamic counterparts. Nevertheless, during periods of general downturns the Islamic indices have shown the same level of efficiency as their counterparts. Furthermore, it appears that during the last two sub-periods under study, the Islamic indices have moved toward efficiency, displaying the same level of efficiency as their counterparts.

KEY WORDS:

• Islamic stock indices
• efficient market
• random walk hypothesis
• martingale difference hypothesis

Notes

1. The fastest-growing segment of the global financial industry is reportedly Islamic investments. Global Islamic financial assets are estimated to reach USD 2.0 trillion by the end of 2014 (Global Islamic Financial Forum 2014).

2. Shari’ah is an Arabic word meaning Islamic laws and regulations.

3. Islamic investments are not allowed in companies whose core business involves alcohol, gambling, conventional financial services, entertainment, pork-related products, tobacco, or weapons. In addition, other company screenings are applied based on certain financial ratios. For instance, companies with unacceptable levels of debt (more than one-third of market capitalization) (Hussein and Omran 2005) or “impure” interest income are excluded from the set of investable stocks. Finally, investments in securities that promise interest payment or investments in derivative securities are not allowed under Islamic law, such as bonds, options and futures contracts (Naughton and Naughton 2000).

4. See El Khamlich et al. (2013).

5. Review Grassa and Gazdar, (2014) for further discussion.

6. See Turhan et al. (2013).

7. See Al-Zoubi and Maghyereh (2007) for a more detailed discussion.

8. For further discussion, see Hussien (2010). Hussien states that Islamic banks appear to be more resilient to the global economic turndown and international financial crisis than conventional banks. They tend to avoid speculative investments, such as derivatives, that many analysts believe led to the financial crisis affecting conventional banks. For many observers, Islamic finance serves as a vehicle for recovering from the international financial crisis. The Islamic banking industry may be able to strengthen its position in the international market as investors and companies seek alternate sources of financing.

9. Please see Çizakça (2014).

10. See Imam and Kpodar (2013).

11. Other Islamic indices include the FTSE, Standard & Poor’s, Stoxx, and Morgan Stanley.

12. For more discussion please review Alam et al. (2013).

13. See Wahyudi and Sani (2014).

14. These two investment schemes which in Islamic finance replaces lending are known as Mudarabah and Musharakah.

15. We thank the referee for his valuable inputs and we applied similar approach as in Ashraf and Mohammad (2014).

16. Due to space limitations, results of descriptive statistics correlation for all sub-periods are not reported in the article, but are available upon request.

17. See Global Islamic Asset Management Report (2014) at http://www.zawya.com/files/islamic-reports/tr-global-islamic-asset-mgmt-report-2014.pdf.