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Leverage, Sensitivity to Market Risk and Contagion: A Multi-Country Analysis for Shari’ah(Islamic) Stock Screening

Listed author(s):
  • el Alaoui, AbdelKader
  • Masih, Mansur
  • Bacha, Obiyathulla
  • Asutay, Mehmet

This study is the first attempt to investigate the relationship between firm’s leverage and systematic risk for seven European countries in relation to Shari’ah (Islamic) stock screening. This paper also aims to examine the shock transmission through the systematic risk and whether less debt could bring more stability to the capital market. Using a dynamic panel technique based on VAR (Vector autoregressive) and dynamic GMM framework, we analyse the levered and the unlevered beta of the firm based on the firm characteristics before adding the country characteristic effects in order to take into account the heterogeneity across firms, which ensures the robustness of the results. We find that leverage is significantly and positively associated with systematic risk and that high leverage augments systematic risk, which is more affected by the nature of the European market rather than the firm characteristic effect. However, the existence of high leverage is indicative of having a big role in making worse the firm conditions under shocks. The presence of these effects is further explored through the responses of the model’s variables to market-wide volatility and shocks. Finally, the sensitivity to the market appears to be impacted by the financial crisis in terms of contagion in leverage with implications for portfolio diversification. Our findings have implications on the stability of firm’s risk exposure and the appropriate level of debt’s commitment to be made by managers.

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File URL: https://mpra.ub.uni-muenchen.de/57685/1/MPRA_paper_57685.pdf
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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 57685.

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Date of creation: 24 Jun 2014
Handle: RePEc:pra:mprapa:57685
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  11. Corsetti, Giancarlo & Pericoli, Marcello & Sbracia, Massimo, 2005. "'Some contagion, some interdependence': More pitfalls in tests of financial contagion," Journal of International Money and Finance, Elsevier, vol. 24(8), pages 1177-1199, December.
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  17. Paul Cashin & Manmohan S. Kumar & C. John McDermott, 1995. "International Integration of Equity Markets and Contagion Effects," IMF Working Papers 95/110, International Monetary Fund.
  18. Dornbusch, Rudiger & Park, Yung Chul & Claessens, Stijn, 2000. "Contagion: Understanding How It Spreads," World Bank Research Observer, World Bank Group, vol. 15(2), pages 177-197, August.
  19. Fernandez, Pablo, 2004. "Reply to "The value of tax shields is equal to the present value of tax shields"," IESE Research Papers D/576, IESE Business School.
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