Does implied volatility (or fear index) affect Islamic stock returns and conventional stock returns differently? Wavelet-based granger-causality, asymmetric quantile regression and NARDL approaches

Abstract

In this paper, we make an initial attempt to compare the asymmetric reaction of Islamic and conventional stock returns to implied volatility -market fear- using Wavelet-based Granger causality, asymmetric quantile regression model (QRM), and NARDL for the sample period from 2008 to 2019. Our findings are three-fold. First, the causal relationship between implied volatility and stock returns is scale-dependent. To make the analysis more robust, we decomposed the daily data using the wavelet filter to consider the potential of different investment horizons. Second, we observe, using QRM, regardless of Islamic or conventional, stock return increases (decreases) following the negative (positive) innovation in the market fear, and the asymmetry is more pronounced at the lowest and highest return regimes. Using NARDL, we find, there is an evidence of asymmetric cointegration and long-run asymmetric relationship. Third, Islamic stock returns tend to be less exposed to the market fear than conventional stock returns across the return regimes at different investment horizons. This relatively lesser sensitivity level of Islamic stock returns can be attributed to their distinct screening features and Islamic markets being more 'decoupled' from the risks facing conventional markets. The results tend to have substantial policy implications for all the stakeholders.