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Forecasting Islamic Stock Market Volatility: an Empirical Evidence from Pakistan Economy

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Forecasting Islamic Stock Market Volatility: an Empirical Evidence from Pakistan Economy P a g e | 17 Forecasting Islamic Stock Market Volatility: An Empirical Evidence from Pakistan Economy Amina Rizwan1 and Ambreen Khursheed1 Abstract Islamic investment particularly, in stocks has revealed an incredible growth in the 21st century. The growing demand of Islamic finance in Pakistan has asserted the main controllers of stock market to launch Islamic index for assisting investors in buying and selling of shares in alignment to their religious beliefs. Though Pakistan is deficient in having a proper Islamic stock market but Al-Meezan and Karachi Stock Exchange has initiated an Islamic stock market by the name of Karachi stock exchange Meezan index (KMI-30). This study uses time series analysis for the forecasting of Islamic stock index of Pakistan under the influence of volatility. The daily data of KMI-30 of five days per week starting from 1st September 2008 to 3rd May 2012 is taken. The output reveal that Muslim investors can earn substantial revenues by investing in Islamic stock indices and can also achieve their peace of mind by aligning their investments to their religious values. The results of Box-Jenkins methodology show that ARIMA model with the value of (2, 1, 0) and Generalized Autoregressive Conditional Heteroskedasticity shows that GARCH with the value of (1, 1) are the best models for forecasting of KMI-30 in Pakistan. Hence, the study assists policy makers, practitioners and investors who desire to make alignment in their financial investment and religious values. Keywords: KSE-100 Index, Shari’ah, Stock Performance, Generalized Autoregressive Conditional Heteroskedasticity. 1. Introduction: Stock market is a place where buying and selling of financial and industrial securities take place (Hosseni, 2011). The investor may assume that he can make millions from the buying and selling of securities but unfortunately, the reality paints a different picture. Forecasting has been done in many fields but the financial markets forecasting is more complex. The different researchers proposed the different parameters to predict or forecast the trend of stock price for investors. So a trustworthy forecasting is required to predict the future of investors (Hosseni, 2011). During 1970’s a huge number of Muslims were not taking part in stock market due to the prohibition in Islam for participating in certain business activities. In the early 1990’s a revolution in religious investment took place by operating of equity investment by the operation of Islamic equity funds (Omran, 2005). According to a careful estimation there is an investment of 230 billion available to Islamic financial markets and this amount is growing by 15% annually (Rashidin, 2004).In Pakistan the Islamic banking industry is also growing by 73% during last eight years (SBP-2011). The total assets volume under Islamic banking in Pakistani market up till now is 641 Billion Rupees which capture about 8% of market share (SBP-2011). The major challenge for Islamic banking and industry is management of liquidity by investing in market securities. The Shariah compliance security only allows investing in an Islamic bank, and the interest based securities are not allowed to invest in Islamic banks. Normally Islamic banks follow two features one is to perform interest-free banking and the other is to do business in those things which are permissible in Muslims religion (El Khamlichi and Sarkar, 2013). In worldwide the eight Islamic indexes are Financial Times Islamic Index Series (FTSE), Dow Jones Islamic Index group (DJIM), Morgan Stanley Capital International Islamic Index Series MSCI, Standard and poor sharia index (S&P), HSBC Amanah Global Equity Index Fund (HSBC), American Islamic Index (AMERI) and Karachi Meezan Index i.e. KMI-30 (Murzaban, Derigs, & Sayeed, 2008). This study is about KMI30 that is Karachi Meezan Index. It is a local index of Karachi which is established for the checking of Shariah Compliance status of security. In Pakistan the three stock exchanges currently working are Lahore Stock Exchange (LSE), Islamabad Stock Index (ISE) and Karachi Stock Index (KSE). The Karachi stock index is the main index includes KSE100 index, KSE all share index and KMI30 that is Islamic stock index working in Pakistan (Naqvi, Karachi Stock Exchange, 2011). 1 Lecturer, School of Accounting and Finance, FMS, UCP [email protected] 1 Lecturer, UCP Business School, FMS, UCP. [email protected] UCP Management Review Volume 2 Issue 1 2018 P a g e | 18 The KMI 30 is established to check the status of a security before investment by IFI i.e. International Financial Institutions. The KMI-30 index is the largest free float Shariah compliant companies listed at Karachi Stock Exchange. The screening of Shariah complaint is conducted by Al Meezan Investment Management. The Shariah compliance companies are selected on the basis of free float capitalization and volume of trade. The re-composition of the KMI-30 index takes place semi-annually. The KSE Meezan index (KMI30) was launched by the alliance between Al Meezan Investment Management Ltd and with the Karachi Stock Exchange (KSE) in 2008 (Naqvi, 2011). Karachi Meezan Index is also calculated on the basis of free float market capitalization. It means at any point KMI shows free float market value of Islamic Index shares in Pakistan. The objective of the KMI-30 index is to provide a gauge for the determining the performance of Shariah Compliant equity investments. The construction of Shariah complaint will increase the participation and enhance the trust of people investing in faith-based equities. (Hanif, 2011). The six requirements of Shari’s compliance are as follows: 1. The core business of a company should be done on Shari’s lines and must be halal. Any unlawful (haram) for example dealing in conventional bank insurance, tobacco, arms manufacturing, alcoholic drinks, pork production or anything related to non-Islamic activities are not allowed. 2. Interest-based financing should be less than 40%. In other way debt to assets ratio should be at least less than 40%. 3. The investment ratio of non-complaint to the total assets should not be more than 33%. The amount of total interest based loans should not be greater than 33% of market capitalization. 4. The Ratio of Shari’s non-complaint income to the total revenue must be lesser than 5%. 5. The share price in the market should not greater than the amount of net liquid assets per share. A liquid asset is an asset which can only be traded on par value according to Sharia’s rule. Liquid Assets include bills receivable, promissory notes and accounts receivables and preferred shares. 6. The ratio of liquid assets to the total assets should be 20% of all illiquid assets. The formula is given below Net Liquid Assets Per share = Total Assets- Assets Illiquid - Current Liabilities – Long-Term Liabilities No of shares outstanding The top 30 companies are included in KMI-30 index as per above criteria. The technical committee will use 15,000 points as the base value and 30th June 2008, will serve as the base period of index. The daily maintenance of index will be according to board policy framework set by stock exchange and Al Meezan Investments. They will ensure that Islamic Index will maintain their continuity while balancing between frequent replacements (Arouri et al., 2013). In the last few decades there is tremendous rise in growth and acceptability in expansion of Islamic financial products in Pakistan. Some attempts are made to assess the performance of KMI-30 with other stock indexes in Karachi from its launch in the year 2008. It was seen that KMI-30 index provided a return of 40% to investors and KSE-100 during the same situation with the 30% stocks that are most liquid provide negative results (El Khamlichi and Sarkar, 2013). UCP Management Review Volume 2 Issue 1 2018 P a g e | 19 Table 1: List of Companies Included in the Recomposed KSE-Meezan 30 Index S-NO. SYMBOL COMPANY S-NO. SYMBOL COMPANY 01. OGDC Oil & Gas Development 10. DGKC D. G. Cement 02. FFC Fauji Fertilizer 11. MTL Millat Tractors. 03. PPL Pakistan Petroleum 12. PTC P.T.C.L.A 04. POL Pakistan Oilfields 13. NRL National Refinery 05. HUBC Hub Power 14. APL Attock Petroleum Ltd 06. PSO P.S.O. 15. INDU Indus Motor 07. ULEVER Unilever Pakistan 16. ICI I.C.I. Pakistan 08. LUCK Lucky Cement 17. ATRL Attock Refinery. 09. FFBL Fauji Bin Qasim 18. LOTPTA Lotte Pakistan PTA 19. SNGP Sui Northern 25. TRIPF Tri-Pack Films 20. PICT Pak Int. Cont. Ltd 26. MARI Mari Gas 21. SHEL Shell Pakistan. 27. ACPL Attock Cement Pak. 22. MEBL Meezan Bank Ltd. 28. CPL Clariant Pak. 23. GLAXO Glaxo Smith Kline 29. PRL Pak Refinery 24. THALL Thal Limited 30. HABSM Habib Sugar (Karachi Stock Exchange, 2012) Through different principles of Quran and Sunnah Muslims can easily know the right or wrong and just and unjust ways of earning money and acquisition of wealth. An important injustice in dealing with a transaction is taking monetary advantage without giving any value. Riba is a prominent source of unjustified advantage and it is prohibited in Islam. The Holy Prophet censured those who collect riba. Riba means expansion and growth without bearing hardships. While, every increase or growth is not necessarily prohibited in Islam. The riba is the premium paid to the lender by the borrower with the original amount (Chapra, 1984). (Razi, 2008) stated the true meaning of riba regarding Islam. According to him Allah swt states in Quran: ”تُ ف ِل ُحو َنَ َلعَ َّل ُك مَ ال ل َه َواتَّقُو اَ ُّم َضا َع َف ًةَ أَ ض َعا ًفا ال ِ ربَا تَأ ُكلُو اَ لَ آ َمنُو اَ ا َّل ِذي َنَ أَيُّ َها يَا“ “O you who have believed, do not consume usury, doubled and multiplied, but fear Allah that you may be successful” (ALQuran 3:130).
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