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Testing the Conventional and Islamic Financial Market Contagion: Evidence from Wavelet Analysis


  • Saiti, Buerhan
  • Bacha, Obiyathulla
  • Masih, Mansur


A major issue facing the investors in the financial markets of the contemporary world is to identify whether the observed stock market fluctuations are due mainly to contagion or fundamentals. This is due to the fact that if the fluctuations are mainly due to a contagion, then it is something like a ‘virus’ which would disappear after a few days. In contrast, if the fluctuations are mainly due to fundamentals, then it is something like a ‘pneumonia’ which is likely to continue for a long time. This study is the first attempt at testing whether there has been any contagion among the Shari’ah-compliant stock indexes during the most recent international financial crisis: the US subprime crisis of 2007-2009 and the Lehman Brothers collapse in 2008, with the application of a time-frequency decomposition technique known as ‘wavelet approach’ both in discrete and continuous forms recently imported to finance from engineering sciences. We analyze the daily data covering the period from June 2005 to December 2011 for the 18 MSCI conventional and Islamic stock market indexes of the Islamic (Malaysia, Indonesia, Turkey, GCC ex-Saudi) and non-Islamic countries (Japan, China, Korea, Taiwan and Hong Kong). Our study is focused on investigating the following empirical question: are the co-movements of selective stock markets normal (interdependent) or excessive (contagious) during the first and the second wave of the financial crisis? Our findings based on the time-frequency decomposition of wavelet approach are as follows: i) The wavelet correlation analysis indicates that, there is no clear evidence of contagion at any time-scales during the subprime mortgage crisis in USA; ii) However, during the collapse of Lehman Brothers, in all conventional stock indexes of non-Islamic countries except Japan, the wavelet correlation coefficients changed significantly at the first time-scale implying that there was a clear evidence of contagion at the first time-scale iii) But the conventional stock indexes of Islamic countries did not suffer from contagion excepting Indonesian MSCI stock index due to overlapping of confidence intervals iv) In all Islamic stock indexes in both Islamic and non-Islamic countries excepting China and Hong Kong Islamic MSCI indexes, the wavelet correlation coefficients changed insignificantly at all scales. Therefore, we fail to reject the null hypothesis implying that there was no clear evidence of contagion at all time-scales excepting China and Hong Kong. Additionally, for robustness, we studied the dynamic correlations between two continuous wavelet transforms through wavelet coherency analysis. The findings whether the stock comovements triggered by the financial crises were showing interdependence or contagion are plausible and intuitive and have implications for both the conventional and Shari’ah-compliant stock markets in terms of asset allocation strategy of risk managers and for policymakers’ optimal policy response to crises.

Suggested Citation

  • Saiti, Buerhan & Bacha, Obiyathulla & Masih, Mansur, 2014. "Testing the Conventional and Islamic Financial Market Contagion: Evidence from Wavelet Analysis," MPRA Paper 56907, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:56907

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    References listed on IDEAS

    1. Ulrich Derigs & Shehab Marzban, 2008. "Review and analysis of current Shariah-compliant equity screening practices," International Journal of Islamic and Middle Eastern Finance and Management, Emerald Group Publishing, vol. 1(4), pages 285-303, November.
    2. Kaminsky, Graciela L. & Reinhart, Carmen M., 2000. "On crises, contagion, and confusion," Journal of International Economics, Elsevier, vol. 51(1), pages 145-168, June.
    3. Seif El-Din Tag El-Din & M. Kabir Hassan, 2007. "Islam and Speculation in the Stock Exchange," Chapters,in: Handbook of Islamic Banking, chapter 15 Edward Elgar Publishing.
    4. Rua, António & Nunes, Luís C., 2009. "International comovement of stock market returns: A wavelet analysis," Journal of Empirical Finance, Elsevier, vol. 16(4), pages 632-639, September.
    5. Tiwari, Aviral Kumar, 2013. "Oil prices and the macroeconomy reconsideration for Germany: Using continuous wavelet," Economic Modelling, Elsevier, vol. 30(C), pages 636-642.
    6. Carmen M. Reinhart & Sara Calvo, 1996. "Capital Flows to Latin America: Is There Evidence of Contagion Effects?," Peterson Institute Press: Chapters,in: Guillermo A. Calvo & Morris Goldstein & Eduard Hochreiter (ed.), Private Capital Flows to Emerging Markets After the Mexican Crisis, pages 151-171 Peterson Institute for International Economics.
    7. Carmen M. Reinhart, 2002. "An Introduction," World Bank Economic Review, World Bank Group, vol. 16(2), pages 149-150, August.
    8. Gencay, Ramazan & Selcuk, Faruk & Whitcher, Brandon, 2005. "Multiscale systematic risk," Journal of International Money and Finance, Elsevier, vol. 24(1), pages 55-70, February.
    9. Ahlgren, Niklas & Antell, Jan, 2010. "Stock market linkages and financial contagion: A cobreaking analysis," The Quarterly Review of Economics and Finance, Elsevier, vol. 50(2), pages 157-166, May.
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    Cited by:

    1. repec:eee:intfin:v:50:y:2017:i:c:p:135-155 is not listed on IDEAS
    2. Umirah, Fatin & Masih, Mansur, 2017. "Should the Malaysian Islamic stock market investors invest in regional and international equity market to gain portfolio diversification benefits ?," MPRA Paper 79762, University Library of Munich, Germany.
    3. Ahmad Monir Abdullah & Abul Mansur Mohammed Masih, 2016. "Diversification in Crude Oil and Other Commodities: A Comparative Analysis," Asian Academy of Management Journal of Accounting and Finance (AAMJAF), Penerbit Universiti Sains Malaysia, vol. 12(1), pages 101-128.
    4. Yang, Lu & Cai, Xiao Jing & Zhang, Huimin & Hamori, Shigeyuki, 2016. "Interdependence of foreign exchange markets: A wavelet coherence analysis," Economic Modelling, Elsevier, vol. 55(C), pages 6-14.
    5. repec:rjr:romjef:v::y:2018:i:1:p:5-19 is not listed on IDEAS
    6. Ding Bo & Engku Rabiah Adawiah Engku Ali & Buerhan Saiti, 2016. "Sukuk Issuance in China: Trends and Positive Expectations," International Review of Management and Marketing, Econjournals, vol. 6(4), pages 1020-1025.
    7. Ding Bo & Engku Rabiah Adawiah Engku Ali & Buerhan Saiti, 2016. "Sukuk Issuance in China: Trends and Positive Expectations," International Review of Management and Marketing, Econjournals, vol. 6(4), pages 1020-1025.
    8. Hosen, Mosharrof & Masih, Mansur, 2017. "Are Islamic risk factors blessings or curse for stock return? evidence from Malaysia based on dynamic GMM and quantile regression approaches," MPRA Paper 79738, University Library of Munich, Germany.
    9. Buerhan Saiti & Mansur Masih, 2016. "The Co-movement of Selective Conventional and Islamic Stock Indices: Is there any Impact on Shariah Compliant Equity Investment in China?," International Journal of Economics and Financial Issues, Econjournals, vol. 6(4), pages 1895-1905.
    10. Ali, Hakim & Masih, Mansur, 2016. "Evidence of cross-country portfolio diversification benefits: The case of Saudi Arabia," MPRA Paper 72180, University Library of Munich, Germany.

    More about this item


    Wavelet time-frequency decompositions; Contagion; Interdependence; Wavelet Correlation; Wavelet coherence; conventional and Shari’ah-Compliant Stock markets;

    JEL classification:

    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics
    • P5 - Economic Systems - - Comparative Economic Systems

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