Academic journal article International Journal of Business

Islamic Economics Rules and the Stock Market: Evidence from the United States

Academic journal article International Journal of Business

Islamic Economics Rules and the Stock Market: Evidence from the United States

Article excerpt


In the Islamic framework of stock markets there is no predetermined interest rate, excess speculative activities and asymmetric information. In these markets there are good intentions in trades and stocks are obtained not in vanities. It has been shown that debt financing and economic waste through excess speculative activities cause a reduction in stock price and returns. A model of stock price for a large country was developed and tested for the S&P 500 Index. It was found interest rate, outstanding government debt and deficits result in a reduction of stock price for the sample period of 1973 Q1 - 2011 Q4. It was also found that the excessive speculative activities during the 1871 Q1 - 2011 Q4 period resulted in bubbly stock prices in the United States and the excess speculative activities added misleading information to stock prices so that stock returns fell.

JEL Classifications: GI20, G140, GI90

Keywords: Islamic rules, stock price, bubbles, excessive speculative activities

There are at least four rules in Islam that make a transaction acceptable. A stock market or index that is established based on these rules is an Islamic market or index. These rules include not obtaining any property in vanities, a goodwill and intention in trade, the absence of usury and trading goods/stocks based on full symmetric information. Any violation of these rules results in a drastic reduction in stock prices. As Naughton and Naughton (2000) describe, common stocks are legitimate in Islam provided these rules are followed. Short selling and margin trading are severely restricted. The use of equity futures and options is questionable from an Islamic perspective and stock markets must be fully regulated to eliminate wasteful transactions that mean a Tag El-Din (1996)-Kia (2001) normative stock exchange is an optimum stock market.

The current literature concentrates on three aspects of Islamic stock markets: The first is on the outperformance of the Islamic stock markets over the traditional stock markets. For example, Wilson (1997) analyses Islamic equity indexes as ethical investment products and shows, in general, these indexes perform well relative to conventional indexes. Hussein and Ornran (2005) find the Dow Jones Islamic Market Index (DJIMI) outperforms the traditional stock index. However, they found that, during the bear period, DJIMI underperforms the market and the reverse is true in the bull market. Tag El-Din and Hassan (2007) report studies that show DJIMI has done relatively well compared to the Dow Jones World (DJW) Index, but underperfonned in relation to the Dow Jones Sustainability World (DJS) Index. They also report studies that show that the Islamic index performs as well as the Financial Times Stock Exchange (FTSE) All-World Index (1). Al-Zoubi and Maghyereh (2007) examine the relative risk performance of the Dow Jones Islamic index (DJIS) with respect to the DJW index and find that the former outperforms the latter (2).

Abdul Rahim et al. (2008) examine the causality between the Islamic equity world -- Malaysia, the US, the UK, Canada, Japan, Europe, Asia Pacific (with and without Japan), the World Emerging, the World Developed, and the World (excluding the US). They found that Malaysia is a potential investment center capable of offering enormous returns and Malaysia, Asia Pacific (without Japan) and the World Emerging offer the lowest risk per unit of returns. Guyot (2011) finds Islamic indexes are as efficient and globally liquid as traditional indexes, but bring additional portfolio diversification benefits to investors. Furthermore, he finds DJW index exhibits higher levels of informational efficiency than its conventional counterpart.

Finally, the study found the terrorist attacks of September 11 and the invasion of Iraq in 2003 as well as the subprime US crisis affect the price dynamics of Islamic indexes, compared to conventional indexes, by accentuating the divergence of price patterns. …

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