Abstract
•We document strong convergence of Islamic and conventional investments across time.•Sectoral divergence is evidenced only in conventional investments during crises.•Convergence dynamics of Islamic investments are more distinct during crises.•On average Islamic investments offer 7% risk reduction in a portfolio at 64 bp/month.•During Covid-19 investors could pay 466 bp for Islamic diversification benefits.
This paper goes beyond the extant comparisons of Islamic and conventional investments by econometrically assessing their convergence dynamics, in a dataset spanning over 1996–2020, covering ten business sectors and five episodes of crisis. We use a dynamic multivariate framework to estimate time-varying correlations, which we submit to beta and sigma-convergence analysis. Subsequently we examine how convergence dynamics affect portfolio risk management and crisis propagation. Our results show strong convergence of Islamic and conventional investments. During crises conventional convergence rates double, but Islamic ones are less affected. Sectoral diversification works best for conventional investments; Islamic ones behave as a single entity. On average we document a 7% risk diversification benefit from Islamic investments, at a 64 basis points cost. Yet, at the epicentre of the Covid-19 financial crisis this rises to 466 basis points and highlights the resilience of these investments in an exogenous event. Islamic investments reduce volatility spillovers in the financial system, but they are progressively less insulated across time. Our findings withstand a battery of robustness checks and are primarily useful to policy makers and investors.