DIAGNOSTIC OF INNOVATIONS AND VOLATILITY PERSISTENCE IN EMERGING MARKETS: EVIDENCE FROM SUKUK AND STOCK INDICES

This paper analysis the persistence of shock and volatility of both Islamic and conventional financial markets, as well as the natural correlation between those markets. This study used the Bivariate BEKK-GARCH (1,1) model to examine the persistence of shock and volatility based on the daily prices in Dubai Islamic Capital Market (Sukuk index) and conventional Stock Market (DFM index). The results showed that both Sukuk and stock market indices were affected by their own news, while the volatility was persistent during the period of this research. The study also found a negative correlation between prices in both Sukuk and Stock markets during the Dubai debt crisis indicating that Islamic bonds were considered as a good portfolio diversifier. This study defines the natural correlation between the daily prices of both Sukuk and stock market, unlike the other studies which used returns. In addition, the empirical results might be valuable for investors and market makers to ensure a good portfolio diversification strategy. International Journal of Islamic Business and Economics Available at http://e-journal.iainpekalongan.ac.id/index.php/IJIBEC ISSN 2599-3216 E-ISSN 2615-420X Vol 4 No 2 2020


Introduction
The last decades witnessed a wide expansion of Islamic finance, which is part of a consistent and integrated framework which considers finance as a supporting factor in the smooth functioning of real economic activity. It has offered a wide series of financial products developed to meet the requirements of a specific group of people, in a way which does not compromise their religious and ethical beliefs. The mechanism of Islamic capital market is rather different from the familiar capital market. Financial actors are guided by legal norms laid down in the legislation of the country, like for conventional market, but not only, they are also committed to respect meticulously the rules prescribed in the Holy Quran. Under this law, all Islamic financial transactions must be free of the following (Nikonova,T et al , 2015;Elfakhani and Hassan ,2005 ) : (a) The interest is prohibited (rhiba); (b) The risk should be shared; (c) The speculative behavior is prohibited (maysir); (d) Use of asymmetric information is banned (gharar); (e) The contracts should be respected; (f)Trade transactions allowed by the Islamic norms should be financed only by Halal industries.
Due to the excellent investment opportunities, and the large choice of both conventional and Islamic investment tools offered in emerging markets such as Malaysia and the Middle East countries, investors are attracted to those markets more than ever. And it is known that volatility is one of the most attractive characters of emerging market, and investors know that they are likely to make huge profits if they understand the mechanism of such markets, and how the Islamic investment products interact with their conventional counterparts. This is why it is essential to understand the nature of the relationship between Shariah compliant tools and stocks and how investors can profit from the specificity of the link between them.
Indeed, forecasting financial markets correlations and volatility persistence have gained an enormous importance from investors, policy makers and different practitioners in finance worldwide, that is given to the huge impact of a good modelling process and a meticulously drawn previsions from academic researchers as well as from market makers to shed the light on the investments opportunities offered in the markets. Thus, both conventional and Islamic markets are becoming more and more decorticated for a better understanding of every little part of their mechanisms, and that attention to the volatility investigations is vital for a more efficient portfolio's management strategy. In addition, the fact that the volatility is varying over time and that its persistence is depending on the development of the market its self and the time series as well, may be the biggest challenge for the researchers and econometrician when investigating volatility of a given equity or market.
One area of Islamic finance that attracted and continues to attract lot of interest on the part of the business community worldwide is the global Sukuk market. So, what are these unconventional bonds? What characteristics do they have to their conventional counterparts? How has this sector prospered? And what are the challenges facing it?
To clarify the picture, it is necessary to define these financial instruments, underlining the main characteristics that distinguish them from traditional bonds. In addition, to understand all aspects of the subject, it is crucial to reveal the development of the global Islamic sukuk market since its first appearance.
Sukuk ‫صكوك‬ plural of Sakk ‫صك‬ is an Arabic term meaning certificate. In financial sense, sukuk refer to Shari'ah-compliant bond, according to the Islamic Financial Services Board, these financial tools can be defined as a certificate representing a proportional undivided ownership right in tangible assets, or a pool of predominantly tangible assets, or a business venture (ISFB, 2009). Sukuk can be of many types (fourteen eligible sukuk types have been identified by the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI). There are requirements for Sukuk to be considered in compliance with the Shariah law, the most fundamental characters are as follow (Godlewski et al.,2013) : First, the certificates must represent ownership in tangible assets, usufructs or services from revenue-generating firms. Second, payments to the investor come from after tax profits and finally, the value repaid at maturity date should follow the current market price of the underlying asset.
The Sukuk Market in the mid-1990s. The first attempt to resolve the liquidity problem faced by Islamic banks has been done by the Central Bank of Malaysia in 1983. So, the bank started its work without using the interest from Government securities, and instead launched government investment certificate, representing privacy bonds. In 1992, the Malaysian government has issued $ 600 million Sukuk bonds in international markets (Rezaei, 2013) The graph below shows the Sukuk issuance from 2001 to 2016. We notice that the sukuk market grew sharply from 2001 until 2007 when the global prices have far exceeded US$ 25 billion. However, in 2008, the market showed a decline of about 30%,due to uncertainty in the global capital market as a result of Great recession in 2008. Nevertheless, Islamic bond prices recovered in 2009, because, the global economy has just tried to convalesce from the crisis.
Furthermore, it is noticed from the graph below, the overall sukuk prices are increasing during the post crisis period. In 2012 sukuk market registered the biggest expansion. Nevertheless, the prices fall again from 2013 to 2016 due to the overall economic distress worldwide.

Figure1: Total sukuk issuance 2001-2016
Source: IIFM Newsletter, March, 2017 In order to face the sukuk market challenges, the standardized contracts need to be endorsed by the Shari-ah Board of Islamic infrastructure institutions such as AAOIFI 1 , IIFM 2 and IFSB 3 in order to give it an international dimension and acceptability in court litigation (Muhammad, 2008). Despite the efforts of Islamic finance standard setters, in many countries the industry is governed by a regulatory and supervisory framework developed for conventional finance. Therefore, it does not fully take into account the special nature of Islamic finance (Al-Maraj, 2014). Moreover, apart from the regulatory and tax aspects, the main challenge of Islamic finance is based on innovation to offer products that meet both 1 AAOIFI: Accounting and Auditing Organization for Islamic Financial Institutions 2 IIFM International Islamic Financial Market 3 IFSB Islamic Financial Services Board the criteria of compliance with regulations, compliance with Islamic precepts but also financial and economic profitability. From a regional point of view, the GCC countries are experiencing a significant evolution in the Islamic finance industry, and we fund that Dubai is looking after the highly privileged position of being the centre of Islamic sukuk in the Middle East, and one of the major players in Islamic finance worldwide along with Malaysia and the United Kingdom. The ambitious initiative toward transforming Dubai into a Global Centre for Islamic Sukuk aims in the first place at making Dubai a hub for the Islamic finance undustry and therefor contributing to the attraction to a huge liquidity to the Dubai Financial market, hence potentially also transforming Dubai into the world capital of Islamic finance.

literature Review
Islamic financial tools have notably grown, feeding the debate on these alternatives financing instruments. El Khalichi et al (2014) investigate the efficiency of Islamic benchmarks and their conventional counterparts, by testing the random walk hypothesis using variance ratio tests. Their results show that Islamic indices have the same level of (in) efficiency as conventional ones. While connoly et al (2005) investigate the linkage between Islamic and conventional market, the author claim that stock-bond market correlation decreases with the increase of stock market uncertainty, suggesting that bonds could be a better hedge against stock market downturns. Also, Chiang et al (2016) shows that stock and bond prices tend to move in the same direction. El Alaoui et al (2015) use wavelet analysis, attempting to analyze the co-movement dynamics at different time scales of Islamic Dubai Financial Market (DFM-UAE) index returns with their counterpart regional Islamic indices returns. Their study's results divulge that closer market tend to have contagion effect, showing higher correlation and higher interdependence with a certain time delay.
In addition to that, others ( Naifar ,2015 ;Sclip et al., 2016) , look at the topic from a volatility perspective. Naifar, N.(2015) explore the dependence structure between Islamic bonds yields and stock market returns and volatility in the case of Saudi Arabia. The author use three Archimedean copula models namely Gumbel, Clayton, and Frank. The research's result show that the dependence structure between sukuk yields and stock market volatility are symmetric and linked with the same intensity. From the same perspective, Sclip et al.(2016) show that volatility linkages between sukuk and regional market indexes are higher during financial crisis. The researchers argue that given the lower volatility of Sukuk compared to equity, sukuk could be a good diversifer for investor's portfolio.
Further, The use of the Multidimensional GARCH (MGARCH) models in financial market studies has been numerous. We can mention earliest work of Bollerslev (1990) about the changing variance structure of the exchange rate regime in the European Monetary System, assuming the correlations to be time invariant. Lien and Luo (1994) evaluated the multi-period hedge ratios of currency futures in a MGARCH framework. Karolyi (1995) examined the international transmission of stock returns and volatility using different versions of MGARCH models.
Finally, this research paper attempts to identify whether there is any impact of Islamic bonds on international stock market volatility, using a pile of time series econometric methods in order to add a scientific value proven by tests statistics.

Research Method
The researchers use the daily data of Dubai Islamic Capital Market (Sukuk Index) and conventional Stock market (DFM index) prices, extracted from the Thomson Reuters I deal Rating database and investing database respectively, from the period of 01/04/2009 to 29/12/2017. Extending our Univariate-GARCH(1.1) allow to estimate variance-covariance matrix, we specify the mean equation of the SUKUK and stock market prices series as follow: Where: Psu, Pst : are vector of definite prices of sukuk and stock market series, respectively. , : are the autoregressive coefficient in the conditional mean equation for sukuk and stock marlet prices.
, : are the long drift coefficient. , : are the residuals.
(Baba-Engle-Kraft-Kroner)BEKK-model, acronym refers to specific parameterization of the multivariate GARCH model developed by Engle and Kroner(1995). The simplest Bekk representation for the N*N conditional covariance matrix Ωt takes the form: Whether: Can upper triangular N*N matrix , A and B are unrestricted N*N matrix, and quadratic representation automatically guarantees that Ωt is positive definite. We can show our diagonal BEKK-GARCH(1.1), N=2 as follow : Hence, the diagonal BEKK-GARCH(1.1) is : From the result of both PP and ADF tests, we notice that our variables are not stationary at level and have unit root because their probability is higher than the critical value, but at the first difference, they became stationary. First, fascia3.1 shows that one period lagged sukuk price explaine the changes in current sukuk price , same for the stock market index. This means means that historical prices are represented by actual prices which is coherent with efficient market hypothesis (Timmermann, A., & Granger, C. W.2004).

Co-integration test:
Second, the fascia3.2 part of the table show that we see that ARCH ( β ) and GARCH (σ derives positive estimates which are statistically significant at 1% level. We can say that conditional variance of both sukuk and stock market are sensitive to their own past shocks, and their volatility are persistent and vary progressively over time. Further, the volatility of sukuk is found to be driven mainly by the forecast variance (GARCH term) than the past shocks or news (ARCH term), which is consistent with Rahman et al (2013). This result suggests that any innovation will have a significant effect on the prices fluctuation of both sukuk and stock markets of the Dubai financial market and will take some time before the prices gradually return to equilibrium.
The volatility of the Dubai stock market can be attributed to the Dubai debt crisis. In fact, the government borrowed 80 billion dollars in short delay (four year) to transform the landscape of the city aiming to be the new real estate and tourism hub. But this incredible challenge was not without consequences, the Dubai real estate sector suffered from a high property depression in the global scale and without any surprise this event had repercussion on the stock market, represented by the volatility of the Dubai stock market general index (DFM) prices.
Moreover, we examine conditional correlation between Sukuk and DFM in order to observe how their prices behave in relation to each other. Cor(SUKUK,DFM)

Figure2: Conditional correlation of the Sukuk and Stock Market Indices:
From the figure we notice that for the first three years (1000days) the correlation is varying between positive and negative coefficient, the relationship between our two assets is extremely volatile and tends to vary between 0.92 and -0.92. Further, this volatility is due to the nature of the sukuk that are hybrids between action and bond, and that result is coherent with Sclip, A et al (2016). Also, the negative dependence between our two equities can benefit the investors, and can provide good portfolio diversification, this is consistent with (Naifar, 2016) study's results.
The volatility persistence of the trading assets is due to the dubai financial market crisis as demonstrated by the graph. However, The graph also show that at the beginning of the 4th year and until the end of the study's period, the correlation becomes equal to zero, which means that our two assets are no longer correlated, otherwise there is no measurable co-movement among the two investments.

Conclusion
It is known that market participants take into consideration the expected returns as well as expected risk. Hence, high volatility points out high uncertainty and this is why market's volatility is considered as the cornerstone of both long and short-run traders' strategy. Indeed, when the prices fluctuate its provide opportunities for investors to buy stocks, bonds or indexes (conventional or Islamic) when prices are low then the investors wait for cumulative growth down the road.
The paper concludes that both sukuk and stock market indices are affected by their own news and shows volatility persistence over the study period. The general environment of the Dubai financial market suggest that the fluctuation and sensitivity of investigated equities are related to the nature of the market as a fast-growing emerging market on the one hand and to the economic and political event changes likewise the Dubai financial debt as the main trigger for the market tremble. Moreover, the negative degree of correlation between Sukuk and Stock Market Prices plays a meaning role in the performance of the Islamic bonds as good portfolio diversifier.