HERDING BEHAVIOR IN ISLAMIC AND CONVENTIONAL STOCK MARKETS – EVIDENCE FROM EMERGING ASIAN ISLAMIC FUNDS

Abstract

The purpose of this study is to investigate investor Herding, an irrational behavior from the Behavioral Finance domain, in both conventional and Islamic stock markets of Indonesia and Pakistan. The study employs the methodology of Chang, Cheng, & Khorana (2000) to test herding in which they calculate the Cross Sectional Absolute Deviation(CSAD) of returns as an indicator of herding. The daily price data for the constituents of JII30, LQ45, KMI30 and KSE100 indices have been used to represent the Islamic and conventional stock markets of Indonesia and Pakistan respectively. The analysis spans five years of data starting from Jan 1, 2015 – Dec 31, 2019. The study further incorporates asymmetric effects of rising/falling markets, volatility and trading volume in the analysis to test if the effects of herding are prominent in these conditions. Finally, this study tests if the Islamic stock market herding is influenced by conventional stock market returns. The findings of the study indicate that Islamic stock markets are more prone to irrational behaviors like herding than conventional stock markets. Specifically, it finds no evidence of herding in the Indonesian conventional stock markets, but some evidence of herding in the Indonesian Islamic stock markets. In Pakistan, there is strong evidence of herding in the Islamic stock markets, specifically, when they are rising, falling and highly volatile. Whereas, the conventional stock market of Pakistan indicates herding in the rising and falling markets only, Finally, the study finds some impact of conventional stock market herding on Islamic stock market herding, but very limited evidence of Islamic stock market herding influenced by conventional stock market returns, both in Indonesia and Pakistan. This paper contributes adding to the conventional finance vs Islamic finance debate in the Behavioral Finance context by identifying some serious behavioral anomalies in the Islamic equities market, which they have claimed to be considerably safer from in past literature.