Co-movement and information transmission between conventional and Islamic equities in Sri Lanka

Abstract

This study investigates the co-movement and information transmission between conventional and Islamic equity indices in Sri Lanka. Methodology: This study uses daily data of All Share Price Index and Dow Jones Islamic Market Sri Lanka Index from 2013 to 2023 for conventional and Islamic proxies. Descriptive statistics, cross-correlation, DCC-GARCH, and wavelet analysis were used for the investigation. Findings: Analyses reveal synchronous correlation yet lead-lag dynamics between the indices. The Islamic index has lower volatility, clustering, and persistence than the conventional index. Localized volatility patches and scale-dependent synchronicity suggest diversification opportunities to optimize risk-adjusted returns. Originality: This study uniquely integrates DCC-GARCH and wavelet analysis to examine the dynamic, time-varying relationships between Islamic and conventional equity markets in Sri Lanka’s dual financial system. This approach helps embrace both short-run changes and long-run movements to gain in-depth co-movement and spillovers, as well as potential diversification gains within an emerging financial market. Implications: The insights from this study are important for investors to optimize diversified portfolios by exploiting time-varying correlations. The identified lead-lag dynamics, bidirectional information flows, and scale-dependent synchronization between the indices enable both investors to predict market movements for effective asset allocation and regulators to monitor market efficiency, stability, and implement shock mitigation measures.