The Impact of the Financial Reforms Influenced by Religious Financial Principles on the Stock Market in the Kingdom of Saudi Arabia

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Date
2023
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Saudi Digital Library
Abstract
This thesis aims to understand the effect of the financial reforms introduced by the Capital Market Authority (CMA) in Saudi Arabia in 2015 on the performance of stock market segments based on Islamic financial principles (IFP). These financial reforms, which include attracting qualified foreign institutional investors (QFIIs) and the reclassification (upgrading) of the stock market’s status to become an emerging market, aim to improve the capital market’s regulatory framework and foster its growth. Based on this background, this study examines how stock market performance has been impacted by comparing market changes pre- and post-reform in terms of return, level of volatility, interdependence of the market with other markets (the spillover effect) and asset allocation decisions. The study uses a time series of daily data for five Saudi stock indices, which are based on IFP, and three global markets (Brent, WTI and S&P 500) for a 12-year period that started on January 04, 2010. These indices include three pure Islamic stock indices (IS1, IS2 and IS3), a mixed stock index (MS), and a non-Islamic stock index (CS). For the purpose of analysis, collected data are divided into two subsamples to represent the pre- (2010–2015) and post-reform periods (2016–2021). The analysis of descriptive statistics shows that all indices recorded a decline in average return and all other risk-adjusted return measures (i.e., the Sharpe ratio and Treynor ratio) in the post-reform period. However, the historical risk measures, such as standard deviation, skewness, value at risk and conditional value at risk, used signal an increase in overall risk level during the post-reform period. Reductions in returns and increases in risks could have been affected by correcting previously mispriced stocks as a consequence of strengthening market regulation (Singh & Roca 2021). To gain better insight into the changes in the risk and return characteristics in the Saudi stock market, probable changes in the volatility patterns (leverage effect of daily Saudi stock returns and volatility persistence) have been examined using GARCH-family econometrics models. The findings of our econometric analysis indicate that bad news carries a larger and longer effect on market volatility in the post-reform period irrespective of the nature of the shares. This could be due to the integration of the Saudi stock market with global markets (Jayasuriya 2005). The findings also show that conventional and mixed stock indices are more vulnerable to bad news than Islamic stock indices. This could be due to the differences in investment strategies (active or passive) used by investors who hold Islamic stocks and those who hold conventional (non-Islamic) stocks. Islamic stockholders seem to have passive strategies, which could lead to fewer stock transactions (Alam et al. 2017). The volatility spillover across Saudi stock indices, three other global indices (two crude oil price indices (Brent and WTI) and one global stock index (S&P 500) has been examined to determine how global integration, which was one of the main aims of the financial reforms, has impacted the Saudi stock market. As the Saudi economy is heavily dependent on petroleum production and distribution, oil price movements are detrimental to all economic activities in the country. Therefore, an investigation of the impact of oil price movements on stock returns is important. Through econometric analysis conducted using ARMA-GARCH, CCF and VAR-GARCH-BEKK, the study determined the volatility interdependence between oil market indices, the US stock market, and the Saudi stock market. The findings indicate bidirectional volatility spillover between each pair of all indexes investigated during both periods, with spillover increasing in the post-reform period. This suggests that liberalising the Saudi stock market with Islamic stock indices has resulted in stronger interdependency with the oil market and US stock market compared to the non-Islamic stock index. The findings are then used to obtain the implications on the portfolio management such as optimal portfolio weights and hedge ratios for asset allocation decisions. The findings encourage the allocation of more capital to Saudi stock indices rather than oil and the allocation of a lower proportion of Saudi stocks in a Saudi/S&P 500 portfolio for risk-averse investors during all periods. It also suggests reducing oil weight and increasing S&P 500 weight when reconstructing a portfolio with Saudi stocks in the post-reform period. The findings of this study have important implications for portfolio construction, suggesting the need to consider the IFP. Moreover, these findings indicate that advancing the liberalisation of the Saudi market can have significant benefits. Not only is this expected to bolster the local economy in alignment with Saudi Vision 2030, but it also holds potential for contributing to the achievement of the United Nations' sustainable development goals. Finally, this research discusses further implications for policy and highlights the need for future investigations in this area.
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Keywords
Financial markets, Stock market, risk management, financial reforms, Capital Market Authority, Saudi Arabia, Islamic financial principles, economy, volatility, Spillover, Asymmetric, financial econometrics
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