Monetary Policy and Symmetric Impact: Evidence from the Volatility Dynamics of Global Islamic and Conventional Equity Indices Using The GARCH Model

Abstract

Research Question: This study investigates whether Shariah-compliant equity markets are insulated from the spillover effects of conventional US monetary policy shocks, challenging the decoupling hypothesis. Motivation: A significant scholarly and practitioner narrative suggests that the prohibition of interest (riba) in Islamic finance creates a decoupled asset class, offering a haven during conventional monetary tightening. This presents a compelling puzzle: in an interconnected global system, can a major financial segment truly remain immune to the world’s dominant discount rate? The research builds upon foundational work on international monetary policy transmission, studies on Islamic market integration (e.g., Hammoudeh et al., 2014), and literature on asymmetric volatility. Idea: The core hypothesis is that US monetary tightening exerts a statistically significant negative effect on Islamic equity returns. The dependent variable is the Dow Jones Islamic Market Index (DJIMI) return. Key independent variables include the Federal Funds rate, risk aversion (VIX), the economic cycle (OECD Indicator), and commodity prices. Data: The analysis uses monthly data from November 2006 to November 2024. The primary data sources are Bloomberg and the Federal Reserve Economic Data (FRED), encompassing the Global Financial Crisis, the zero lower bound period, and the recent tightening cycle. Method/Tools: The empirical framework employs Generalized Autoregressive Conditional Heteroskedasticity (GARCH) and Glosten-Jagannathan-Runkle (GJR-GARCH) models to simultaneously estimate mean spillover effects and capture the clustering and asymmetry of return volatility. Findings: Results decisively reject decoupling. A 100-basis-point US rate increase reduces the monthly DJIMI by approximately 3.7%. Islamic equities also exhibit a significant "leverage effect," where negative shocks increase future volatility more than positive ones, though this asymmetry is slightly weaker than in conventional markets due to lower financial leverage. This confirms integration via discount rate and risk appetite channels. Contributions: The paper's primary contribution is a definitive empirical refutation of the interest-rate decoupling hypothesis for Islamic equities, demonstrating their embeddedness in the global financial system. It contributes to the literature on international finance spillovers and Islamic finance by introducing a nuanced analysis of volatility dynamics, offering crucial insights for asset pricing, risk management and policy.