The Relationship Between Islamic Mutual Funds and Oil Prices: Which Leads The Other?

Abstract

This paper attempts to investigate the causal relationship between Islamic mutual funds and oil prices using a rich dataset from leading world markets. The issue is an important one to examine because, since the 1990s, Islamic mutual funds have emerged to occupy an important place in all the major stock markets of the world. On the other hand, oil is the most critical and crucial commodity and occupies a key role in the economies of many countries, especially in the Middle East. The Middle East has more than half of the world’s proven oil reserves and remains the locus of the global oil market. To meet the demand of Muslims (particularly in Middle Eastern countries) who wish to invest in equities, including non-conventional ones, Islamic equity funds have emerged rapidly since the early 1990s. Much attention has been given to the temporal relationship between oil prices and index returns. However, there is a serious gap in the literature on the temporal relationship between oil prices and Islamic mutual fund performance, and this paper attempts to fill this gap. The empirical results show that oil prices do not cause changes in Islamic mutual fund performance; rather, Islamic mutual funds cause changes in oil prices. Moreover, the results also indicate that there is a long-run relationship between Islamic mutual funds and oil prices. These results are consistent with previous studies, which show that during recession periods, stock markets lead oil prices because the equilibrium between demand and supply for oil is volatile and because oil is not only a fuel but also an investment commodity.