Evaluating diversification approaches: A comparative analysis of traditional, Islamic indices in the United Kingdom, and alternative investment options

Abstract

This study explores the diversification potential of the United Kingdom’s (UK) conventional and Islamic stock indices, Bitcoin, gold, crude oil, and the GBP/USD exchange rate from 2011 to 2022 using methodologies such as VECM, MODWT, MGARCH-DCC, and CWT. The findings indicate that UK indices, gold, and Bitcoin respond to changes in crude oil prices and GBP/USD rates, whereas GBP/USD and crude oil show low correlation, offering diversification benefits. Gold consistently maintains a low correlation with UK indices during global disruptions, such as the 2020 pandemic and the 2022 Ukraine-Russia conflict, reinforcing its reliability as a diversification asset. However, Bitcoin shows potential as a diversification tool despite its high volatility, which is a concern. Crude oil’s effectiveness as a diversification asset diminishes for holding periods beyond 64 trading days. The study also reveals that the global financial crisis significantly impacted both UK Islamic and conventional indices, challenging the role of the Islamic index as a safe haven and suggesting that Shariah screening may not necessarily shield Islamic markets during economic downturns. These findings provide investors with essential insights into selecting equity indices and commodities for portfolio diversification and underscore the importance of advanced methodologies to understand correlation and volatility dynamics.