Ramadan Effect

Ramadan fasting is one of the most celebrated religious rituals in the world. Ramadan is a positively perceived feast (in the same way as other feasts like Christmas, New Year etc.) therefore we can anticipate it should positively affect investor psychology. Academic research confirms this speculation. Equity returns during Ramadan are almost nine times higher and less volatile than during the rest of the year. A simple market timing strategy could be therefore created by holding an equally weighted basket of ETFs, from countries with a large Muslim population during the month of Ramadan and staying in cash during the rest of the year. Due to its simplicity this strategy could be easily incorporated into various portfolios.

Fundamental reason

Academic research postulates that the euphoria derived from Ramadan could influence investor behavior in Islamic markets. The upbeat mood during Ramadan leads to positive investor sentiment and has a positive valuation effect on equity markets in Islamic countries.

Markets traded
equities
Confidence in anomaly's validity
Strong
Notes to Confidence in anomaly's validity
Period of rebalancing
Monthly
Notes to Period of rebalancing
Number of traded instruments
14
Notes to Number of traded instruments
Complexity evaluation
Simple strategy
Notes to Complexity evaluation
Financial instruments
ETFs, funds
Backtest period from source paper
1989-2007
Indicative performance
6.70%
Notes to Indicative performance
estimated per annum return for strategy, calculated as equity return during Ramadan month ( ~2.7% = (1 + 38.09%)^(1/12) - 1 ) plus cash return (4%) during rest of the year
Estimated volatility
not stated
Notes to Estimated volatility
Maximum drawdown
not stated
Notes to Maximum drawdown
Sharpe Ratio
not stated

Keywords:

seasonality, market timing

Simple trading strategy

The investment universe consists of countries for which stock market index data are available and in which the proportion of population the professing Muslim faith exceeded 50%. Most of the countries could be easily tracked via index ETFs. The research paper we use as an example uses 14 Muslim countries.

Ramadan is the ninth month in the Islamic calendar, which is based on the motion of the moon. The Ramadan month could be calculated by using information on the lunar phases and sunset times from astronomical calendar or information about Ramadan dates from various public sources.

The trading strategy is simple. The investor holds an equally weighted portfolio of ETFs during Ramadan month. He/she is otherwise invested in cash.

Hedge for stocks during bear markets

Partially - Selected strategy is a class of "Market Timing" strategies which try to rotate out of equities during time of stress. Therefore proposed strategy isn't mainly used as an addon to portfolio to hedge equity risk directly, but it is more an overlay which can be used to manage percentual representation of equities (or "equity like asssets") in a portfolio. "Equity Market Timing" strategy can decrease overall risk of equities in a portfolio and it can improve the risk-adjusted returns. Moreover, as strategy's goal is to hold equity market only in a positive times for equity market factor and be out of equities otherwise, therefore this logic can be maybe used to create amended market timing strategy (using original rules) which is out of equities during positive times and holds bonds (or goes short equities) during bad times. This new amended strategy can be maybe used as a hedge/diversification to equity market risk factor during bear markets. However, performance/risk characteristics and overall correlation and quality of suggested ammended strategy can be find out only by rigorous backtest and source academic research paper doesn't give us any clues on how it will perform...

Source Paper

Bialkowski, Etebari, Wisniewski: Piety and Profits: Stock Market Anomaly during the Muslim Holy Month
http://www.econ.canterbury.ac.nz/RePEc/cbt/econwp/1052.pdf
Abstract:
Observed by more than 1.5 billion Muslims, Ramadan is one of the most celebrated religious rituals in the world. We investigate stock returns during Ramadan for 14 predominantly Muslim countries over the years 1989-2007. The results show that stock returns during Ramadan are almost nine times higher and less volatile than during the rest of the year. No discernible difference in trading volume is recorded. We find these results consistent with a notion that Ramadan positively affects investor psychology, as it promotes feelings of solidarity and social identity among Muslims world-wide, leading to optimistic beliefs that extend to investment decisions.

Hypothetical future performance

Other Papers

Almudhaf: The Islamic Calendar Effects: Evidence from Twelve Stock Markets
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2131202
Abstract:
This paper investigates the Islamic calendar seasonal anomalies in the stock returns of twelve countries where the majority of the population are Muslims. We show empirical evidence of statistically significant Islamic calendar seasonal effects in all twelve countries of our sample. We document evidence of positive and statistically significance returns in the month of Ramadan in Jordan, Kuwait, Pakistan and Turkey. Our results provide some evidence against market efficiency.

Al-Issis: THE IMPACT OF RELIGIOUS EXPERIENCE ON FINANCIAL MARKETS
https://econ.duke.edu/uploads/assets/Research/ERID/Al-Ississ%20Final%20Faith%20in%20Muslim%20Financial%20Markets%20Mar%202010-1.pdf
Abstract:
In spite of the important role religion plays in peoples’ lives, its impact on financial markets is seldom researched. This study examines the effect of religious experience during the Muslim holy days of Ramadan and Ashoura on the daily returns and trading volumes of 17 Muslim financial markets. Muslim holy days are especially conducive to isolating the elusive effect of faith and decoupling it from potential contaminants. The study documents statistically significant drops in the trading volume and changes in daily stock returns associated with religious experiences on these holy days. The effect on returns is not unidirectional as Ramadan yields a positive impact on daily returns while Ashoura is associated with a negative effect. Ramadan’s more sacred days are associated with a higher magnitude effect culminating on its holiest day,Ramadan 27th. The study utilizes the heterogeneity of worship intensity within the month of Ramadan to validate that the documented effect is indeed a result of religious experience rather than non-faith aspects of the holy days.

Ramezani, Poughajan, Mardan: Studying Impact of Ramadan on Stock Exchange Index: Case of Iran
http://www.engineerspress.com/pdf/WSJ/2013-12/a5%20%28WSJ-1311205%29.pdf
Abstract:
One of the human characteristic and features is its beliefs. Feature which has important effect on lifestyle, culture, society and decisions making - even economic decisions. Iranian as people that most of them are Muslim has Islamic beliefs. Ramadan is peak of religious beliefs in Islam development in comparison to other beliefs like economic beliefs and soon. In this research, impact of Ramadan as worship and devotion month is exami ned on stock exchange index. Results of this research showed that there is positive and significant relationship between changes of stock exchange index and Ramadan, Shawwal and Rabi Al - Awwal months. However there is negative and significant relationship between stock exchange index and Jumada II, Rabi, Muharram and Rajab months. We examine this relationship for other month and results indicate that there isn’t significant relationship for Jumada al - Awwal, Saffar, Shaban, Dhu al - Hijja and Dhu al Qaeda.