How resilient are Islamic financial markets during the COVID-19 pandemic?

The COVID-19 pandemic has posed a massive disruption to the finance sector. Islamic financial markets are no exception. We explore the resilience of Islamic financial markets to the COVID-19 pandemic vis-`a-vis conventional markets. A comparative analysis of the impact of the first and second waves of COVID-19 is also conducted. We use five Dow Jones Islamic stock indices and two bond indices and their conventional counterparts as proxies of Islamic and conventional financial markets. Using wavelet, wavelet-based Granger causality, hedge ratio, optimal weights, and hedging effectiveness methods from January 1, 2019, to February 26, 2021, our empirical estimates indicate that both Islamic and conventional stock indices are almost similarly affected by the extreme market turbulence triggered by COVID-19. Hence, Islamic stock markets fail to provide diversification benefits. We also unveil no significant differences between the first and second waves of COVID-19 in the case of dependency. Conversely, Islamic bonds exhibit low dependence on their conventional counterparts, indicating their diversification benefits. We further demonstrate that Islamic and conventional bond pairs could be utilized as a strong portfolio mix because the least hedging cost and highest hedging effectiveness are observed in those portfolios, especially during COVID-19. Overall, our results suggest that global Sukuk offers more resilience in times of extreme market turmoil than other instruments considered in this study. Our findings present global investors and regulators with new insights on diversification and hedging strategy with Islamic finance during a worldwide, severe economic crisis. We present some policy recommendations in creating a more sustainable financial system post-COVID-19.