Abstract
The rise of the Islamic capital market in the emerging economy of Malaysia over the past few decades motivates us to investigate the impact of the Syariah compliant status on the level of exchange rate exposure. The Syariah compliant status implies that a company should use a minimal level of debt as capital to finance its operations. Given this, it is hypothesized that Syariah compliant firms should exhibit lower levels of exchange rate exposure than their counterparts, supported by the strong theoretical connection between interest rate and exchange rate. In terms of specification, previous efforts in pricing exchange risk failed to capture the true size of exposure due to the use of single time domain in traditional model. To cater the bias in estimation, this study intends to calculate multi-horizon exchange rate exposure based on maximal overlap discrete wavelet transformation to decompose single series into multiple time domains. The financial risk analysis involves 30 listed non-financial individual stocks in Malaysia having different Syariah compliant status from November 2013 until May 2018. As a result, the study finds no significant difference in currency exposure between Syariah compliant and non-Syariah compliant stocks. Secondly, it is found that the extent of currency exposure and the percentage of exposed firms exhibit non-homogenous trend across different time scales where large amount of exposure is concentrated at higher scale. From policy implications, the study suggests that Syariah compliant firms and non-Syariah compliant firms share the same exchange risk profile where exchange risk management routine is expected to be identical for both groups. Besides, the enhanced level of exposure at higher scale requires vigorous financial risk hedging strategies especially within widened investment interval.
Highlights
Since the abolishment of the Bretton Wood fixed exchange rate system in the 1970s, the issue of exchange rate risk remains relevant until now
Despite a significant volume of studies have been devoted in investigating the incidence of exchange rate exposure within developed economies (Jorion [4], Bartram and Bodnar [5]), there has been a little-noted but potentially highly significant level of exposure faced by Malaysian multinational corporations
The major innovation of the study lies on the use of maximal overlap discrete wavelet transformation (MODWT) in unveiling scale-dependent exchange rate exposure of Syariah compliant firms (SCF) and non-Syariah compliant firms (NSCF) in Malaysia
Summary
Since the abolishment of the Bretton Wood fixed exchange rate system in the 1970s, the issue of exchange rate risk remains relevant until now. With the glitch in Bretton Woods Agreement in 1973, the exchange rate risk had escalated to where currencies were left to float and fluctuate, resulting in more significant gains and losses if no risk management is put in place (Bernoth & Herwartz [10]). This is especially true when exchange rate directly affects financial assets and liabilities of firms that are denominated in foreign currency and firms with foreign operations. The ICMD and the SAC are important supporting bodies to enhance the Islamic components which stands as a reference center for all issues concerning Syariah-compliant matters
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