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Does Bitcoin Comove and Share Risk with Sukuk and Islamic Stock Indexes? Evidences using Time-Frequency Approach

Walid Mensi
By Walid Mensi
2 weeks ago
Does Bitcoin Comove and Share Risk with Sukuk and Islamic Stock Indexes? Evidences using Time-Frequency Approach

Shariah, Sukuk

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  1. Does Bitcoin Comove and Share Risk with Sukuk and Islamic Stock Indexes ? Evidences using Time-Frequency Approach Walid Mensi,a,b,1 Mobeen Ur Rehman,c2, Debasish Maitra d3, Khamis Hamed Al-Yahyaeeb4 Ahmet Sensoye5 aDepartment of Finance and Accounting, University of Tunis El Manar, Tunis, Tunisia of Economics and Finance, College of Economics and Political Science, Sultan Qaboos University, Muscat, Oman c Shaheed Zulfikar Ali Bhutto Institute of Science and Technology (SZABIST), Islamabad, Pakistan d Indian Institute of Management Indore, Indore e Faculty of Business Administration, Bilkent University, Ankara, Turkey bDepartment Abstract This study attempts to examine the co-movements between Bitcoin and various Islamic assets. We apply Cross Wavelet Transform and Wavelet Coherence Analysis approaches along Value at Risk. The co-movement is stronger and in the same direction at low frequency suggesting the benefits from diversification with Bitcoin may be relatively less important for the long-term investors than the short-term investors. A co-movement in the opposite directions at high frequency implies better benefits of hedging through diversification into Bitcoin and Islamic equity markets in the short-run. Finally, the benefits of portfolio diversification with Bitcoin and Islamic assets vary across time and frequencies. Keywords: Bitcoin; Islamic stock market; Sukuk, co-movements; VaR based wavelet approach. Corresponding author: walid.mensi@fsegt.rnu.tn, +216-97 617 178 mobeen.rehman@szabist-isb.edu.pk 3 debasishm@iimidr.ac.in 4 yahyai@squ.edu.om 5 ahmet.sensoy@bilkent.edu.tr 1 2
  2. Does Bitcoin Comove and Share Risk with Sukuk and Islamic Stock Indexes ? Evidences using Time-Frequency Approach Abstract This study attempts to examine the co-movements between Bitcoin and various Islamic assets. We apply Cross Wavelet Transform and Wavelet Coherence Analysis approaches along Value at Risk. The co-movement is stronger and in the same direction at low frequency suggesting the benefits from diversification with Bitcoin may be relatively less important for the long-term investors than the short-term investors. A co-movement in the opposite directions at high frequency implies better benefits of hedging through diversification into Bitcoin and Islamic equity markets in the shortrun. Finally, the benefits of portfolio diversification with Bitcoin and Islamic assets vary across time and frequencies. Keywords: Bitcoin; Islamic stock market; Sukuk, co-movements; VaR based wavelet approach. 1
  3. 1 . Introduction Co-movements among financial time series is of primary concern for investors, portfolio managers and policy makers alike. Extreme co-movements among financial markets differs according to downturn and upturn market conditions. By accounting for the co-movements, market participants benefit of additional information on asset allocation and portfolio design. The behavior of cross-markets is time varying and varies under bullish and bearish markets. Dynamic, non-linear and asymmetric behaviors thus make the use of linear correlations not suitable to address such topic and leads to spurious estimations in asset allocation and regulatory decision making. Given the fact above, capturing the co-movements among financial time series has become more important than ever in the last two decades, emphasized particularly during the Asian crisis in 1998 and the global financial crisis (GFC) in 2008-2009. The globalization and the increasing integration among traditional financial assets (conventional stock shares, foreign exchange asset among others) resulted in occurrence with such crises. The later crisis results in an emergence of two important financial assets (i) the first one is the Islamic stock market and Sukuk which has known an important growing and (ii) the second is the creation of Bitcoin (BTC) market. Islamic stock market constitutes a new investment alternative to investors in order to diversify their portfolio. This asset plays the role of safe haven asset during meltdown financial periods, suggesting investors’ flight to quality behavior during this turbulent period (Mensi et al., 2015). The increasing demand of the Sharia compliant stocks explain in large portion the importance of this asset into investor’s portfolio. On the other hand, Sukuk, as an Islamic bond market, showing a significant increase around the Islamic and non-Islamic economies. Sukuk contains an entitlement to rights of ownership of a given class of asset where borrower gives it to a lender as a proof of ownership (Haque et al., 2017). In contrast to conventional bond, Sukuk 2
  4. pays profit instead of interest . Abdul Halim et al. (2017) document that Sukuk deter managerial expropriation through a set of contractual arrangements which earmark the cash flows of the project to the underlying assets. As far as for Bitcoin, it is the largest cryptocurrency in terms of market capitalization, compared to more than one hundred cryptocurrencies. Moreover, the market capitalization of Bitcoin more than doubled in 2016, increasing from 6.5 billion USD on 31 December 2015 to 15.5 billion USD on 31 December 2016. It accounts for more than 80% of all cryptocurrency capitalization as of the same year (Al-Yahyaee et al., 2018). Even though the academic literature does not count Bitcoin as a currency yet due to its high level of volatility and not being backed up by a central bank (Baur, Lee, and Hong, 2015; Cheah and Fry, 2015; Dwyer, 2015; Dyhrberg, 2016), it is still accepted an alternative albeit speculative investment. In fact, once declared as a scam or a typical bubble by financial giants such as JP Morgan, Goldman Sachs and George Soros, now is being considered as an emerging asset by the same people and planned to be included in their portfolios. In addition to all of that, CBOE has introduced Bitcoin futures in December 2017, which makes this cryptocurrency an official investable asset not only in the eyes of the investors, but also policy makers as well. The contribution of this paper is to first examine the co-movements between these emerging asset classes through an analysis on Bitcoin prices and both Dow Jones Sukuk index and eight major Islamic stock market indexes. Second, we analyze the systemic risk by calculating the Value at Risk (VaR) which is a popular risk evaluation tool. Specifically, we consider the Dow Jones Islamic Market World Index (DJIM), Dow Jones Islamic Market Titans 100 Index and six Dow Jones Islamic markets country based for US, Europe, Asia-Pacific, UK, Japan and Canada. The DJIM index is weighted by free-float market capitalization and excludes any share stocks that 3
  5. do not follow shariah rules . DJIM items prohibit business activities like Alcohol, Tobacco, Porkrelated products, conventional financial services (banking, insurance, etc.), weapons and defense and entertainment. In addition, shares are removed from DJIM index if financial ratios (not more than 33%) are not suitable for Islamic investment purposes. The Dow Jones Islamic Market Titans 100 Index assesses the performance of the largest 100 stocks traded globally that pass rules-based screens for adherence to Shariah investment guidelines. Dow Jones Sukuk index measures the performance of global Islamic fixed income securities.1 Islamic financial assets provide new investments not only for Muslim investors as well as for non-Muslim investors. To do this, we apply both Cross Wavelet Transform and Wavelet Coherence Analysis approaches. Wavelet is a popular instrument for analyzing the nonlinear correlations between financial series. This approach is helpful for traders interested by short-term co-movements and institutional investors and policy makers concerned by long-term co-movements. However, it analyzes the co-movements between Bitcoin and Islamic market indexes over time and across different frequencies ranging from lowest to highest frequency. Aguiar-Conraria and Soares (2011) document that low (high) frequency movements when the wavelet transform stretches (compresses) into a long (short) wavelet function. This decomposition is crucial as it considers the different behavior of investors as some investors (traders and portfolio managers) are concerned by the short-term and other like institutional investors and policy makers by the long term. It further stretches to isolate the slow and persistent movements and determine the potential of spillovers, contagion, diversification benefits and downside risk. The wavelet cross-spectrum might lead to ambiguous results because, if one of the spectra is local and the other one shows a very high jump, the jump generated in the cross-spectrum, which is a multiplication of continuous 1 For more details see https://us.spindices.com 4
  6. wavelet transformation of two series , cannot be attributed to the relationship between two series. For this reason, we also apply the wavelet coherency analysis to determine significant comovements between two series both in the frequency bands and time intervals. After addressing the co-movements of Islamic markets (stock and Sukuk) and Bitcoin we use the popular risk evaluation tool namely VaR. This risk management measure provides a full picture of risks that are reflected in extreme co-movements during bearish and bullish market states. The VaR under time scale accounts for the exposure to risk under different frequencies and over time horizons. This is crucial for making decisions by both short-term and long-term investors. It offers the potential losses in the shorter-time horizons (or higher frequencies) and the longer-time horizons (or lower frequencies). The results show that the co-movement between Bitcoin and Islamic equity returns varies in the time frequency space. The co-movement between the considered markets is stronger and in the same direction at low frequency. This result suggests the diversification benefits may be relatively less important for the long-term investors than the short-term investors. A relatively small co-movement in the opposite directions at high frequency implies better benefits of hedging through diversification into Bitcoin and Islamic equity markets in the short-run. In addition, the strength of the co-movements between Bitcoin and Islamic equity returns vary across countries. The pair Bitcoin-Sukuk shows co-movement over 128-256 days cycles, where Sukuk is leading. As for VaR-based risk analysis, the portfolio diversification benefits with Bitcoin and Islamic equity/Sukuk/Titan 100 vary across time and frequencies. The portfolio risk increases at low frequencies than at high frequency (except Islamic equity index returns of Canada and Titan 100). The co-movements with Sukuk also decrease the portfolio risk. The graphical evidence shows a sudden increase in portfolio risk is in the short-term during 2015-2016. In the long run, Islamic 5
  7. equity market returns of the US , UK, Europe, Asia-pacific and Japan might not offer portfolio diversification benefits while equity returns of Canada and Sukuk can continue to be part of the portfolio. Overall, the Islamic equities can be included in the portfolio for hedging if the investor’s horizon is very short-term. The remainder of this article is structured as follows. Section 2 outlines the methodology used in the study. Section 3 describes the data and descriptive statistics. Section 4 presents and discusses the empirical results. Section 5 summarizes the main findings and offers our primary conclusions. 2. Methodology 2.1. Cross or Squared Wavelet Coherence Approach To investigate the relationship between Bitcoin and Islamic equity market returns, we employ the wavelet technique developed by Hudgins et al. (1993) and Torrence and Compo (1998). We use cross wavelet coherency approach (WTC) with phase difference (PD) to analyze time frequency relationship between Bitcoin and sampled Islamic indices. The cross wavelet coherency approach is considered as a correlation coefficient in time-frequency space whereas phase difference gives information about the synchronization or delays between co-movement of two given time series (see Aguiar-Conraria et al., 2011). According to Aguiar-Conraria et al. (2011), the cross wavelet coherency approach is also defined as a ratio of cross spectrum to the product of spectrum of the two series and can be considered as a correlation in both time and frequency domain between the two series. Like traditional correlation coefficients, the coefficients of wavelet coherency in case of higher correlation between the two time series approaches 1, and zero in case of no correlation or association between them. Wavelet power 6
  8. spectrum depicts variance in series and larger variance in wavelet power spectrum is depicted by higher power. In this way the cross wavelet power spectrum highlights high covariance value between the two series across different time and frequency arrangement. The specification of wavelet coherency between two time series as proposed by Torrence and Webster (1999) is appended below.