Co-Movement and Volatility Transmission between Islamic and Conventional Equity Index in Bangladesh

Though the issues of co-movement and volatility transmission between Islamic and conventional stock indices have been extensively studied worldwide, this is the first study in reference to Bangladesh to the best of our knowledge. The broad objective of this paper is to investigate whether Islamic stock index provides more diversification benefits than the conventional index from the perspective of cointegration and volatility spillover employing ARDL bounds testing cointegration procedure and GARCH family models. This study uses daily conventional (DS30) and Islamic (DSES) indices from the Dhaka Stock Exchange over the period from 20 January 2014 to 25 June 2018. Typically longer series of data are used in stock market research; however, this study is constrained to take only four and a half years of daily data as Islamic stock index in Bangladesh launched only just in January 2014. The results from ARDL bounds testing and error correction modeling show that both the markets are interlinked in the short-run and long-run. Since two markets move together in the long and short-run, one can predict its future price using any of the index prices. Univariate GARCH(1,1) model finds evidence of volatility clustering in both index returns which have a tendency to last a long time. The results of the EGARCH(1,1) model reveal that both markets are more sensitive to the bad news than with good news. Employing a bivariate GARCH-BEKK model, we find the existence of significant volatility transmission from conventional to Islamic stock market in Bangladesh. Results of GARCH-CCC framework show the evidence of strong direct interconnections between the markets. Finally, we test the presence of time-varying correlation between markets applying the GARCH-DCC model, and the results reveal that correlations are not only conditional but also significantly time-varying. The result also shows that the correlation process is mean reverting. Therefore, we conclude that conventional and Islamic stock markets in Bangladesh do not offer any diversification benefits to investors having both indices in their portfolios. Hence, faith-based investors and portfolio managers should add in other categories of assets in their portfolios to mitigate risk