Motivated by the COVID-19 pandemic, we construct a single factor predictive model for stock returns that incorporates uncertainty index for pandemics and epidemics (UPE). Specifically, we examine whether Islamic stocks are either vulnerable or have better hedge potential when compared to the performance of their conventional counterparts. In general, we find that the Islamic stocks can be used to hedge whereas the conventional stocks are seen to be vulnerable to uncertainty due to pandemics across different time periods. In particular, during COVID-19 pandemic, although the hedging effectiveness of Islamic stock seems to decline, it is still better compared to the worse performance of the conventional stocks. The outcome remains the same even after controlling our model for oil price, geopolitical risk and economic policy uncertainty. We further evaluate the predictive power of the UPE both for the in-sample and out-of-sample periods by comparing its forecast performance with that of a benchmark model. Our results suggest that the consideration of the UPE information in the valuation of stocks is crucial for investment decisions.
Islamic Stock indices and COVID-19 pandemic