Are Islamic stock markets efficient? A time-series analysis

Abstract

This article investigates the weak-form informational efficient hypothesis for three major Islamic stock markets (world, emerging and developed). Unlike previous studies, we applied different parametric and nonparametric tests to investigate efficiency in the short and long horizons. Using recent data over the period May 2002–June 2012, we developed a time-series analysis of Islamic stock price dynamics in the context of the recent global financial crisis (2008–2009). Our analysis offers two interesting results. First, emerging Islamic stock markets seem to be less efficient than developed Islamic markets, suggesting interesting investment opportunities and diversification benefits from this region in both the short run and the long run. Second, nonrejection of the cointegration hypothesis for developed Islamic markets and the global conventional stock market point to efficiency for the former in the long term, even if it is inefficient in the short term. This finding has at least two economic and political implications: (i) investors who seek moderate risk would do well to opt for Islamic funds in developed countries, particularly as they share the same tendency and provide similar expected returns in the long term as conventional funds, (ii) Islamic financial systems can offer a useful model that can help to reform and remodel conventional financial institutions.

Keywords:

• international equity markets
• Islamic Finance
• efficiency tests
• financial crisis
• time-series analysis

JEL Classification:

• C22
• G15

Acknowledgements

We would like to thank the editor and the anonymous referee for their constructive comments and suggestions that helped us to considerably improve the article.

Notes

¹ The Sharia Board is a committee that includes scholars and specialists of Islamic Law who also have strong backgrounds in banking and finance. They are present in different Islamic financial institutions, and their main mission is to control financial activities and check their conformity with Sharia Law in order to help Islamic banks and financial institutions to develop products and services that are compatible with the Sharia.

² See Arouri et al. (2013) for a survey on Islamic Finance (IF).

³ The efficient market hypothesis can be traced back to the pioneering contributions of Bachelier (1900) and Cowles (1933), while modern economics literature begins with Fama (1965) and Samuelson (1965).

⁴ Efficiency tests vary according to efficiency forms and information type (Fama, 1965). However, as mentioned in several previous studies, market efficiency is often not directly testable, and efficiency tests are joint tests based on the presence of an equilibrium model for asset prices.

⁵ Through the interdiction of speculation, incertitude and hazard, the IF industry involves more control of risk-taking and more regulated price volatility (Khan, 2010).

⁶ The DJIM index includes 2700 companies. Different screenings are carried out with different criteria and for different levels to ensure that stocks comply with Sharia law. For instance, to be selected, a company should have a debt ratio of less than 33%; its interest rate income should be minimal; its illicit income should be distributed and its debt should not exceed 45% of its total asset. This screening prefers companies that develop environmental and human policies. The screening also eliminates companies that have activities in sectors that are not Sharia-compliant such as pork, pornography, arms, alcohol, etc.

⁷ As in several previous studies, stock prices are integrated of order 1, noted I(1), according to the Dickey–Fuller and Philips–Perron tests; we thus focus on stock return dynamics.

⁸ For more details of this test, see Lo and MacKinlay (1988).

⁹ This point is not investigated in our study and we leave it for further future research.

¹⁰ For more details on this test, see Brock et al. (1987).

¹¹ denotes the observation number. is the SD of the series under consideration. is the embedding dimension, and is the maximum distance between two pairs.