Can alternative hedging assets add value to Islamic-conventional portfolio mix: Evidence from MGARCH models

Abstract

This study assesses the diversification benefits of combining alternative hedging assets (namely Barclay's U.S. bonds index, crude oil, gold and implied volatility index futures) with Islamic and conventional stock portfolios. We apply the relatively recent techniques of dynamic conditional correlation (DCC), asymmetric DCC (ADCC), corrected DCC (cDCC) and GO-GARCH to account for heavy tails and asymmetric returns. We use dynamic correlations to evaluate the diversification benefits of the combined portfolios with the hedging assets. The findings indicate that all the alternative assets are effective in hedging the Islamic stock portfolios compared to their conventional counterparts. The VIX shows highest hedging effectiveness for both Islamic and conventional stock portfolios. Moreover, Islamic stock indices have greater risk and downside risk-reduction benefits when mixed with the alternative assets. In sum, the development of Islamic stock indices provides alternative opportunities to diversify portfolios globally and across asset classes.