Cointegration and Causality tests

for Islamic and Composite Indices in Malaysia

Author :

Rininta Nurrachmi (www.rininta-nurrachmi.blogspot.com)

Presenter :

Marhamah Muthohharoh

Presented in Conference of Islamic Economics and Finance from Global

Perspective

International Islamic University Malaysia

Saturday, 28 September 2013

Award

First Runner Up for Best Paper

Rininta Nurrachmi (The Author)

She held a Bachelor degree in Agriculture from Bogor Agricultural University (Indonesia) and a Master degree in Economics from International Islamic University Malaysia (IIUM). Before continue her study in IIUM, she has worked for Market Research Company in Jakarta - Indonesia as Quantitative Research Executives, Project Director and Field Administrator.

Marhamah Muthoharoh (The Presenter)

She held a Bachelor degree in Agriculture from Bogor Agricultural University (Indonesia) and now pursuing her Master Degree in Economics at International Islamic University Malaysia (IIUM). Before continue her study in IIUM, she has worked as a Research Assistant in International Center for Applied Finance and Economics (InterCAFE) IPB, Bogor, Indonesia. And as a Non-civil Servant Staff of Macroeconomic Policy Department of State Ministry of National Development Planning Agency, Jakarta, Indonesia.

Introduction

• Background

1. The composite index and shariah index have the same movement during the crisis.

2. Most of the previous papers, elaborate the objective during global crisis which end on 2010.

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HIJRAH EMAS SI

DATA MOVEMENT OF THREE INDICES

Research Objective

To investigate the existence of cointegration and causal direction among FBM KLCI, FBM Hijrah Index and FBM Emas Shariah Index after Bursa Malaysia joint forces with FTSE group.

Literature Review

The Relationship between Islamic and Composite indices

Albaity and Ahmad (2008), Hengchao and Hamid (2011), Chapakia and Sanrego (2007)

There is cointegration

Hakim and Rashidian (2002); Beik and Wardhana (2011)

There is absence of cointegration

Data and Methodology

• Model 𝐿𝑛(𝐶)𝑡= 𝛽0 + 𝛽1𝐿𝑛(𝐻)𝑡 + 𝛽2𝐿𝑛(𝐸)𝑡 + 𝜀𝑡

Ln(C) is natural logarithm for FBM KLCI, measured in local currency

Ln(H) is natural logarithm stock prices in FBM Hijrah Index measured in local currency

Ln(E) is natural logarithm stock closing prices in FBM EmasShariah Index measured in local currency.

Data and Methodology • Data

Duration of data : 1 June 2007 - 31 May 2013

Total sample size : 1479

Source of data : Bloomberg

• Methodology 1. VAR 2. Unit root test : ADF, PP, KPSS 3. Cointegration test : Julius – Johansen

Cointegration 4. Causality direction : short-run granger

causality test

Result and Discussion

• The existence of unit root Stationary at I(I)

• The absence of cointegration or no long-run relationship in the variables.

It indicates that the market is efficient and the error of one series cannot predict the movement of other indices

Unit Root Test Result Augmented Dickey Fuller (ADF) Test

Variables

Constant Trend

Level First-

Difference Conclusion Level First-Difference Conclusion

Ln(Composite) -0.475327 -20.70258*** I(1) -0.475327 -20.7537*** I(1)

Ln(Hijrah) -0.517702 -34.30003*** I(1) -1.570715 -34.32191*** I(1)

Ln(Emas) -0.450988 -33.99737*** I(1) -1.687256 -34.03908*** I(1)

Philip-Perron (PP) Test

Variables

Constant Trend

Level First-

Difference Conclusion Level First-Difference Conclusion

Ln(Composite) -0.428678 -34.43981*** I(1) -1.825535 -34.44221*** I(1)

Ln(Hijrah) -0.485319 -34.27527*** I(1) -1.543376 -34.29369*** I(1)

Ln(Emas) -0.485048 -34.08719*** I(1) -1.688878 -34.11343*** I(1)

Kwiatkowski-Phillips-Schmidt-Shin (KKPSS) Test

Variables

Constant Trend

Level First-

Difference Conclusion Level First-Difference Conclusion

Ln(Composite) 2.734449*** 0.307862 I(0) 0.490875*** 0.131435 I(0)

Ln(Hijrah) 2.377878*** 0.223554 I(0) 0.524364*** 0.080542 I(0)

Ln(Emas) 2.387278*** 0.29573 I(0) 0.525625*** 0.10107 I(0)

Cointegration Test Result

Null Hypothesis

Trace Max Eigenvalue

Cointegration

Rank

Critical Value

(5%)

Cointegration

Rank

Critical Value

(5%)

r = 0 24.01333 29.79707 18.27561 21.13162

r <= 1 5.737722 15.49471 4.490307 14.2646

r <= 2 1.247415 3.841466 1.247415 3.841466

Note: The lag order specified is 1 based on Akaike Information Criteria (AIC).

Causal Direction

Null Hypothesis F-Statistic P-Value Conclusion

(Hypothesis)

LNKLCI does not Granger Cause LNHIJRAH 2.04869 0.0853 Rejected

LNHIJRAH does not Granger Cause LNKLCI 1.14664 0.3329 Accepted

LNEMAS does not Granger Cause LNHIJRAH 2.4534 0.0442 Rejected

LNHIJRAH does not Granger Cause LNEMAS 1.04118 0.3846 Accepted

LNEMAS does not Granger Cause LNKLCI 1.79984 0.1263 Accepted

LNKLCI does not Granger Cause LNEMAS 1.94222 0.101 Accepted

FBM Hijrah Index

FBM KLCI

FBM Emas

Shariah Index

Conclusion

• The cointegration does not exist among the three variables.

• Unidirectional causality occurred between FBM KLCI towards FBM Hijrah index and between FBM Emas Shariah index towards Hijrah index.

• The decline of Shariah index due to crisis in global and domestic was a short-run relationship and it only occurred because of the shock from in FBM KLCI.

• Investing in Shariah compliant securities have attracted local and foreign investors.