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Does investor sentiment impact the returns and volatility of Islamic equities?

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Abstract

In this paper, we estimate generalized autoregressive conditional heteroskedasticity (GARCH) and vector autoregressive (VAR) models to examine whether investor sentiment impacts the returns and volatility of various U.S. Dow Jones Islamic equity indices. The results from GARCH estimations show that changes in investor sentiment are positively correlated with the returns of the Shari’ah-compliant market portfolio. In addition, we find similar results for the three Shari’ah-compliant firm-size portfolios (i.e., large-, medium-, and small-cap). However, this relationship is stronger for harder to arbitrage Shari’ah-compliant stocks; that is, investor sentiment has a greater influence on small-cap equities. Additionally, estimations from the vector autoregressive model confirm the aforementioned results. In terms of volatility, GARCH estimations suggest that bullish shifts in investor sentiment in the current period are accompanied by lower conditional volatility in the ensuing period. In general, our findings suggest that as noise traders create more risk the market seems to reward them with higher expected returns.

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Notes

  1. See Hirshleifer (2001) for a thorough review of the literature.

  2. We would like to thank Ken French for making the data available on his website.

  3. The sample begins in 1996, since data for the Shari’ah equities is first reported in DataStream as of January of that year.

  4. Shari’ah compliant stocks included in the secular portfolios only represent about 13.4 % of the securities.

  5. Correlograms are omitted for brevity, but are available upon request.

  6. Bollerslev et al. (1992) suggest that the GARCH (1, 1) is suitable for most econometric applications.

  7. See Brown and Cliff (2004) for more information.

  8. Table 5 shows the estimated coefficients for the vector autoregressive model. The variables included in the vectorautoregressive model are the change in individual investor sentiment (ΔSENTAAIIt), the change in institutional sentiment (ΔSENTIIt), the returns on the U.S. Dow Jones Islamic large-cap portfolio (Rt,SLG), and the returns on the U.S. Dow Jones Islamic small-cap portfolio orthogonal to large stocks (Rt,SSOB).

  9. The VAR model is the same as the one for Fig. 1; see footnote 8 for more details.

  10. Table 6 shows the estimated coefficients for the vector autoregressive model. The variables included in the vector autoregressive model are the change in individual investor sentiment (ΔSENTAAIIt), the change in institutional sentiment (ΔSENTIIt), the returns on the U.S. Dow Jones large-cap portfolio (Rt,LG), and the returns on the U.S. Dow Jones small-cap portfolio orthogonal to large stocks (Rt,SOB).

  11. The variables included in the VAR model for Fig. 4 are the same as those from Fig. 3.

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Authors and Affiliations

  1. Cameron School of Business, University of St. Thomas, 3800 Montrose Blvd., Houston, TX, 77006, USA

    Daniel Perez-Liston

  2. Department of Economics and Finance, College of Charleston, 5 Liberty St. Beatty Center. Suite 400, Charleston, SC, 29424, USA

    Daniel Huerta

  3. Prairie View A&M University, P.O. Box 519, MS 2310, Prairie View, TX, 77446, USA

    Sanzid Haq

Authors
  1. Daniel Perez-Liston
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  2. Daniel Huerta
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  3. Sanzid Haq
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Correspondence to Daniel Huerta.

Additional information

This research, in part, was funded by Prairie View A&M University’s College of Business summer research grant.

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Perez-Liston, D., Huerta, D. & Haq, S. Does investor sentiment impact the returns and volatility of Islamic equities?. J Econ Finan 40, 421–437 (2016). https://doi.org/10.1007/s12197-014-9290-6

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  • DOI: https://doi.org/10.1007/s12197-014-9290-6

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