1. INTRODUCTION
The financial deregulation and foreign openness process, which accelerated in the late twentieth century, increased trade relations between countries. Especially, the market collapse (Black Monday) in October 1987 and the ‘Asian Financial Crisis’ in 1997 made the integration of international stock exchanges more important (Kılıç & Buğan, 2016, p. 167). Along with technological developments, financial liberalisation accelerates the flow of information between markets and offers different investment opportunities in different geographical regions. However, the rapid flow of information between the markets eliminates the possibility of diversifying the portfolio by bringing the markets closer, and may cause the volatility in a market to spread to another market. In this context, revealing the relationships between markets or financial assets is important regarding the portfolio diversification and risk management.
Some of the new improvements in the global financial system are the establishment of Islamic banks, Islamic equities and bond markets, which are different from their counterparts (Ajmi, Hammoudeh, Nguyen, & Sarafrazi, 2014, p. 214). The Islamic financial system shows significant differences from the traditional financial system in terms of both principles and financial products (Hammoudeh, Mensi, Reboredo, & Nguyen, 2014, p. 190). The Islamic financial system requires all financial transactions to be made based on real assets, as well as sharing the profit and loss of the parties in the contracts (Rejeb, 2016, p. 2). Islamic law constitutes the basis of Islamic finance. In this context, the Islamic finance prohibits interest (riba) to be received and paid; performing overly ambiguous transactions (garar); gambling (maysir) including derivative transactions, which are not based on short sales, real transactions and speculation. In addition to these, Islamic finance is an asset-based financial system that differs from the interest-based conventional system and it establishes a principle to share profit and loss in the transactions (Hammoudeh et al., 2014, pp. 189–190; Shahzad, Ferrer, Ballester, & Umar, 2017, pp. 9–10). Islamic finance is identified with the concept of interest-free finance. Aydin (2012) stated that the compound interest rate in conventional finance is considered to be the eighth wonder of the world (p. 61).
Islamic stocks, one of the broadest range of investment products provided by the Islamic finance industry, have attracted the attention of international investors over the past few years. Portfolio managers and investors are increasingly interested in Islamic stocks that have different characteristics based on Islamic ethical values (Mensi, Hammoudeh, Sensoy, & Yoon, 2016, p. 2457). Stock markets definitely contain the risk-sharing component (Masih, Kamil, & Bacha, 2018, p. 1). Islamic stock indices comprise the shares of enterprises that meet the qualitative and quantitative criteria. However, these qualitative and quantitative criteria may differ between countries (Buğan, 2016, pp. 251–254). There is a difference between the criteria of the Kuala Lumpur Syariah Index (KLSI) Islamic indices in Malaysia and the criteria for the DJIMI and FTSEGII Islamic indices. While the income approach is preferred as the monitoring criteria rather than the activity approach in the DJIMI and FTSEGII Islamic indices, the situation for the KLSI indices is the opposite. According to the activity approach, the activities of the enterprises to be included in the Islamic index should be in accordance with the Islamic rules (Albaity & Ahmad, 2011, p. 163). However, as in the conventional finance system, the index selection for investments in Islamic finance is becoming more important as the global economic structure develops (Dania & Malhotra, 2013, p. 66).
The Islamic financial sector has improved significantly in recent years and it is foreseen that this development will not stop. According to the ICD-Thomson Reuters-published Islamic Finance Development Report-2018, it is estimated that, at the end of 2017, the total amount of global Islamic financial assets reached $ 2,438 billion and it will have reached $ 3,809 trillion by 2023 (ICD-Thomson Reuters, 2018). According to the report, the total Islamic financial assets in the world is dispersed as 71% Islamic banking, 17% sukuk, 6% other financial institutions, 4% Islamic funds and 2% takaful.
It is claimed that Islamic stocks represent a unique class of investment which is called as ‘decoupling hypothesis’, related to Islamic stocks and different from conventional stocks (Masih et al., 2018, p. 5). It is important to know how the investors in the market have differentiated from the conventional investors in terms of their investment preferences for portfolio diversification and risk management. Majdoub and Sassi (2017) stated that individual or institutional Islamic investor behaviour has an impact on market behaviour (Majdoub & Sassi, 2017, p. 16). It is thought that this effect may create different results on the volatility spillover in Islamic markets. Alt...
