Monetary transmissions mechanism for Islamic capital markets: evidence from Markov switching dynamic regression approach

Abstract

PurposeThis study akims to investigate the effectiveness of expansionary monetary policy for Islamic capital markets by studying the impact of decrease in policy rates on seven Islamic equity indices for the period 1996–2019. The transmission mechanism may be different for sampled indices, as they are exposed to Shariah screening that discards certain business sectors and puts limit on debt in capital structure.Design/methodology/approachThis study uses Markov Switching dynamic regression approach of Hamilton (1988).FindingsThe results show little effectiveness of expansionary monetary policy in both Bear and Bull states, for most of the sample indices.Originality/valueTo the best of the authors’ knowledge, no study has made use of dynamic models to assess the association between monetary policy rate and Islamic index prices. Similarly, the authors found no work exploring the effectiveness of expansionary monetary policy actions in different regime for Islamic Indices. This investigation is important in unraveling whether, in the presence of limitations on selection of business activity and choice of capital structure, monetary policy can change the market sentiment, or it will be ineffective. The present study fills this gap.