Hedging Islamic and conventional stock markets with other financial assets: comparison between competing DCC models on hedging effectiveness

Abstract

This study examines the hedging of Islamic and conventional stock markets risks using diverse financial assets (namely gold, crude oil, VISTOXX, VIX, CDSEU and DJCOM). We apply DCC, ADCC and FDCC models to account for heavy tails and asymmetric returns. We use rolling window analysis to construct out-of-sample one-step-ahead forecasts of dynamic conditional correlations and optimal hedge ratios. The findings indicate that the hedge ratios vary and depend upon the inclusion of hedging assets, portfolio composition and model used. The VISTOXX is the best asset to hedge Islamic and conventional stock portfolios. Moreover, the DCC model often leads to diversification benefits and hedging effectiveness better than the others models.