The effect of oil price movements on Islamic and conventional Dow Jones Index returns and volatility

Abstract

This study examines the relationship between oil, conventional index, and Islamic index returns and volatilities. The empirical study implements empirical volatility calculations, regression analysis-ordinary least square estimation. The Islamic index is represented by the Islamic Dow Jones, the conventional index by the Dow Jones industrial and oil by the West Texas Intermediate crude. The sample period includes daily quotes for 9 years from January 1, 2005 through December 31st, 2013. Our empirical results show evidence of significant effects of oil return and volatility on both conventional and Islamic indices during and outside the US financial crisis. More specifically, the response of the Islamic Dow Jones index return to oil return is higher than conventional index in overall sample, either during or outside the crisis. However, the response of Islamic index volatility to oil volatility during the crisis is less than the conventional index. This result is not surprising as the Islamic index involves companies with low borrowing rate and hence low bankruptcy risk. The contribution of the bankruptcy risk to the total risk during crisis periods becomes important than outside the crisis. Nevertheless, the effect of oil volatility on the conventional index movements is lower than that on the Islamic index outside the crisis. This could be attributed to the nature of the Islamic index stock composition and the risk sharing characterizing the related companies.