Is There a Role for Islamic Bonds in Global Diversification Strategies? An Empirical Analysis of Risk Transmissions and Dynamic Correlations

Abstract

This paper explores international diversification benefits of Islamic bonds (sukuk) by examining dynamic spillovers and correlations between sukuk and conventional bond and stock markets. Asymmetric volatility spillover effects are observed from global debt and equity markets to Islamic bonds, suggesting that volatility on conventional markets has opposite spillover effects on Islamic bonds. The analysis of dynamic correlations suggests a low degree of association between these securities and global stock markets with episodes of negative correlations observed, particularly during market crisis periods. The low degree of correlation plays a significant role in the performance of these securities as diversifiers for global stock portfolios. We observe that Islamic bonds can provide valuable diversification benefits for conventional stock portfolios that are not possible to obtain from conventional bonds, underscoring the significance of Islamic bonds as a viable alternative to its conventional counterparts.