Short-term predictability of Islamic stocks following price shocks: evidence from four emerging markets

Abstract

Purpose This study aims to explore the short-term return predictability of Islamic stocks following significant one-day price shocks in four emerging markets: Indonesia, Malaysia, Pakistan and Saudi Arabia, over the period 2015–2024. It tests whether these shocks generate predictable return patterns, challenging the weak form of market efficiency. A key objective is to compare post-shock return behaviour between Shariah-compliant and conventional stocks to assess whether Islamic equity markets behave differently, given their unique ethical and religious screening criteria. The research addresses a gap in empirical literature on Islamic finance by examining price dynamics after extreme market events. Design/methodology/approach The study uses daily stock index data for Shariah-compliant and conventional equities across four markets. Price shocks are defined as daily returns exceeding one, two or three standard deviations from a 50-day rolling mean. Cumulative abnormal returns (CARs) are calculated over the ten days following each shock. Behavioural Finance and the uncertain information hypothesis (UIH) were used to develop the theoretical framework. Two-sample t-tests compare CARs between Islamic and conventional indices to assess differences in post-shock market behaviour. The approach identifies short-term inefficiencies and evaluates whether these vary between Islamic and conventional indices. Findings The results show significant underreaction to positive shocks and overreaction to negative shocks, consistent with behavioural explanations and the UIH. These reactions suggest short-term return predictability, challenging weak-form efficiency in both Islamic and conventional markets. However, two-sample t-tests reveal only limited statistically significant differences between the two categories, indicating broadly similar levels of short-term efficiency. This suggests that the Islamic screening process does not materially alter investor reactions to large shocks in the short run. The findings contribute new evidence of inefficiencies in emerging markets and inform ongoing debates about the efficiency of Islamic equities. Practical implications The findings suggest opportunities for investors to exploit short-term inefficiencies following large shocks, regardless of Shariah compliance. The findings may have implications for investors, particularly in designing short-term investment strategies that could potentially allow them to “beat the market.” Islamic equity investors, portfolio managers and financial product designers may benefit from understanding behavioural biases in post-shock periods. The study also provides empirical support for incorporating behavioural factors in risk models for Islamic portfolios. Originality/value This study is among the first to systematically compare Islamic and conventional equity market reactions to large daily price shocks. It addresses a key gap in Islamic finance literature by integrating behavioural finance theories into the analysis of Shariah-compliant markets. The research adds value by examining short-term inefficiencies across multiple emerging markets using consistent, shock-based methodologies. Its insights are relevant to scholars, policymakers and investors seeking to understand how religious investment constraints interact with behavioural biases and market anomalies.