Dynamic co-integration and portfolio diversification of Islamic and conventional indices: Global evidence

Results from the SD analysis reveal that conventional indices are first-order stochastically dominant during pre-crisis and the financial crisis periods. In the post crisis period no evidence of dominance orders is observed between the two types of indices. During the entire sample period almost all conventional indices give relatively higher monthly returns than Islamic indices at a distinct S-Shape second order stochastic dominance. Findings suggest that the risk-averse investors could increase their wealth and utility by switching from their current Islamic investments to the risky conventional indices to gain a “risk premium”. A clear incentive appears however, for risk seeker investors to optimally investing more in conventional indices in exchange for anticipated higher returns. However, the dominance of conventional indices over Islamic indices offers diversification opportunities for global investors who will hold both types of indices in one portfolio.