Dependence between oil price volatility, Islamic and conventional Dow Jones indexes: Implication for portfolio management and hedging effectiveness

Abstract

The purpose behind this paper is twofold. Firstly, it aims at discussing the relationship between oil price and Islamic as well as conventional Dow Jones indexes. Secondly, it focuses on determining the optimal portfolio hedging strategy. In broader terms, it helps analyze the extreme dependence structure lying between oil price and Islamic as well as conventional Dow Jones indexes, using Kendall Tau estimation through copula approach. More importantly, it is designed to determine the most appropriate hedging strategy fit for oil stock portfolio against the negative variation risk predominating stock market prices. The variables involved in our research are WTI and Brent Oil Price, Islamic Dow Jones index, and conventional Dow Jones index. Using daily data relevant to the period ranging from January 1, 1996 to March 17, 2014, the study applies the FIEGARCH-EVT-Copula and Hedge ratios analysis. The reached findings have revealed that the dependence structure proves to differ noticeably among the Islamic Dow Jones – oil price and the conventional Dow Jones one. Indeed, the Islamic Dow Jones indexes appear to be more dependent on the WTI and Brent oil price than the conventional Dow Jones index. Based on the Hedging ratio and mean–variance approach, investment in Islamic index–oil portfolio has been discovered to be more beneficial as compared to investing in conventional index–oil portfolio.