Abstract

We model the downside and upside spillover effects, systemic and tail dependence risks of the DJ World Islamic (DJWI) and DJ World Islamic Financial (DJWIF) indices, and of Islamic equity indices from Japan, USA and the UK. We draw our empirical results and conclusions by implementing a robust modeling framework consisting of Value-at-Risk (VaR), conditional VaR (CoVaR), Delta conditional VaR (ΔCoVaR), canonical vine conditional VaR (c-vine CoVaR), and time-varying and static bivariate and vine copula models. Full sample estimations indicate larger downside spillover effects and systemic risk for the DJ Islamic Financials World and USA Islamic indices, while Islamic indices from Japan and the DJ World financials have greater exposure to upside spillover risk effects. During the financial crisis the USA and UK Islamic indices display higher downside systemic risk; and the strongest negative tail asymmetric dependence occurs between the DJ Islamic Financials World, and the Islamic indices from Japan and the DJ World financials. Implications of the results are discussed.

Introduction

Never before has been more important to understand the spillover effects across financial stock markets given the increasing globalization phenomenon, the continuous integration of economies and financial markets, and the increasing important role that stock markets play in determining the performance of world economies. It was during the recent global financial crisis of 2008-2009 when it became evident that portfolio losses are largely influenced by the inability of individual and institutional investors to deal on a timely manner with negative tail co-movements, spillover effects and the systemic risk stemming from the instability of toobig-to-fail financial institutions. Since then, an increasing trend of financial modeling has attempted to better understand and trace the underlying linkages connecting financial markets across countries. Financial regulators in particular, given the size of international Islamic equity markets which has reached trillions in asset value, have began to consider the potential risk effects extreme negative tail movements and co-movements in some countries’ Islamic equity markets could exert on Islamic (and conventional) equity markets from other parts of the world. All this in the light of the objectives targeted by the Basel III standards, which have highlighted the importance of maintaining the stability of the financial system and of strengthening its resilience (BCBS, 2011). It is under these circumstances where the problem of accurately and adequately estimating the extent to which some aggregate and representative global financial equity markets influence the performance of other financial equity markets scattered across regions of the world becomes relevant and is worth investigating.