Skip to main content
SpringerLink
Log in

Is Cross-Hedging Effective for Mitigating Equity Investment Risks in the Indian Banking Sector?

  • Original Research
  • Published:
Asia-Pacific Financial Markets Aims and scope Submit manuscript

Abstract

Can the investments in securities devoid of futures be effectively hedged? If so, what is the best cross-hedging instrument? The study evaluates the efficacy of the cross-hedging strategy for small and medium investors interested in banking sector stocks devoid of futures using the market index, sectoral index and stock futures from the same sector. The risk mitigation ability of each portfolio is estimated for different trade horizons using near-month futures and spot prices. The optimal futures contract size for minimising risk exposure is calculated using the Diagonal BEKK GARCH model with a minimum-variance approach. The cross-hedging portfolio with BANK NIFTY futures performs consistently well in a longer trading horizon with higher hedging costs. A cross-hedging portfolio with single stock futures also shows an excellent risk reduction potential but is less expensive than other alternatives. Fundamental investors achieve risk reduction up to 53.74 per cent cross-hedging using BANK NIFTY futures. Investors can construct cross-hedging portfolios with a closely matching return profile and hold these positions for a longer trade horizon to achieve higher risk reduction.

This is a preview of subscription content, log in via an institution to check access.

Access this article

Log in via an institution

Price excludes VAT (USA)
Tax calculation will be finalised during checkout.

Instant access to the full article PDF.

Institutional subscriptions

Similar content being viewed by others

References

  • Alam, M. S., Rabbani, M. R., Tausif, M. R., & Abey, J. (2021). Banks’ Performance and Economic Growth in India: A Panel Cointegration Analysis. Economies

  • Alexander, C., & Barbosa, A. (2007). Effectiveness of minimum-variance hedging.The Journal of Portfolio Management,46–59

  • Alizadeh, A. H. (2004). “Effectiveness of oil futures contracts for hedging international crude oil prices.“. Working Paper.

  • Allen, D., & McAleer., M. (2017). Theoretical and Empirical Differences Between Diagonal and Full BEKK for Risk Management. Tinbergen Institute Discussion Paper

  • Anderson, R. W., & Danthine, J. P. (1981). Cross Hedging.Journal of Political Economy,1182–1196

  • Aquilina, J., Manda, I., Cesari, G., Charpillon, N., Filipovic, Z., & Lee, G. (2009). Modelling, Pricing, and Hedging Counterparty Credit Exposure: A Technical Guide. Germany: Springer Berlin Heidelberg

    Google Scholar 

  • Awang, N., Azizan, N., Ibrahim, I., & Said, R. (2014). Hedging Effectiveness Stock Index Futures Market: An Analysis on Malaysia and Singapore Futures Markets. International Conference on Economics, Management and Development, 24

  • Baillie, R., & Myers, R. (1991). Bivariate Garch estimation of the optimal commodity futures hedge.Journal of Applied Econometrics,109–124

  • Bandaranayake, S. (2019). How does bank competition affect systemic banking crises? Colombo Business Journal, 1–24. doi:https://doi.org/10.4038/cbj.v10i2.49

  • Batten, J. A., Kinateder, H., Szilagyi, P. G., & Wagner, N. F. (2021). Hedging stocks with oil. Energy Economics, 93, doi:https://doi.org/10.1016/j.eneco.2019.06.007

  • Benet, B. (1992). Hedge period length and ex-ante futures hedging effectiveness: the case of foreign-exchange risk cross hedges.Journal of Futures Markets,163–175

  • Bhaduri, S. N. (2008). Optimal hedge ratio and hedging effectiveness of stock index futures: Evidence from India.Macroeconomics and Finance in Emerging Market Economies,121–134

  • Bhaduri, S. N., & Durai, S. N. (2008). Optimal hedge ratio and hedging effectiveness of stock index futures: Evidence from India.Macroeconomics and Finance in Emerging Market Economies,121–134

  • Bonga-Bonga, L., & Umoetok, E. (2016). The effectiveness of index futures hedging in emerging markets during the crisis period of 2008–2010: Evidence from South Africa. Applied Economics

  • Brajesh Kumar, & Pandey, A. (2013). Market efficiency in Indian commodity futures markets.Journal of Indian Business Research,101–121

  • Brooks, C., Davies, R. J., & Kim, S. S. (2007). Cross Hedging with Single Stock Futures. Assurances et Gestion des Risques;, 473. doi:https://doi.org/10.2139/ssrn.614004

  • Butterworth, D., & Holmes, P. (2001). The hedging effectiveness of stock index futures: Evidence for the FTSE-100 and FTSE-mid250 indexes traded in the UK.Applied Financial Economics,57–68

  • Caldarelli, C. E., & Souza, W. A. (2011). Comparative analysis of the hedging effectiveness for soybean using ols and bivariate Garch Bekk Model. Revista de Economia

  • Cecchetti, S. G., Pok-sang, L., & Mark, N. (1988). “Mean reversion in equilibrium asset prices.“. National Bureau of Economic Research

  • Chand, S., & Shahid Kamal, I. A. (2012). Modeling and volatility analysis of share prices using ARCH and GARCH models.World Applied Sciences Journal

  • Chang, C. Y., Lai, J. Y., & Chuang, I. Y. (2010). Futures hedging effectiveness under the segmentation of bear/bull energy markets.Energy Economics.,442–449

  • Chang, E., & Wong, K. (2003). Cross-Hedging with Currency Options and Futures.Journal of Financial and Quantitative Analysis,555–574

  • Chang, J. S. (1987). A risk-return measure of hedging effectiveness: a comment,.Journal of Financial and Quantitative Analysis,373–376.

  • Chen, S., Lee, C., & Shrestha, K. (2003). Futures hedge ratios: A review.Quarterly Review of Economics and Finance,433–65

  • Chen, X., & Jittima Tongurai. (2021). &. Cross-commodity hedging for illiquid futures: Evidence from China’s base metal futures market. Global Finance Journal, 49. doi:https://doi.org/10.1016/j.gfj.2021.100652

  • Chkili, W. (2016). Dynamic correlations and hedging effectiveness between gold and stock markets: evidence for BRICS countries. Research in International Business and Finance. doi:https://doi.org/10.1016/j.ribaf.2016.03.005

    Article  Google Scholar 

  • Choudhry, T. (2004). The hedging effectiveness of constant and time-varying hedge ratios using three Pacific Basin stock futures.International Review of Economics and Finance,371–385

  • Chunhachinda, P., de Boyrie, M., & Pavlova, I. (2018). Measuring the Hedging Effectiveness of Commodities. Finance Research Letters

  • Lien, D. (1996). The Effect of the Cointegration Relationship on Futures Hedging: A Note.The Journal of Futures Markets,773

  • Dias, R., & Santos, H. (2020). “Stock market efficiency in Africa: Evidence from random walk hypothesis.“. LIMEN

  • Durai, S., Bhaduri, N., & Sethu, S. R. (2008). Optimal hedge ratio and hedging effectiveness of stock index futures: evidence from India.Macroeconomics and Finance in Emerging Market Economies,121–134

  • Ederington, L. H. (1979). March). The Hedging Performance of the New Futures Markets. The Journal of Finance, 34(1), 157–170

    Article  Google Scholar 

  • Ederington, L. H. (1979). The hedging performance of the new futures markets.Journal of Finance,157–170

  • Engle, R. F. (1982). “Autoregressive Conditional Heteroskedasticity with Estimates of the Variance of United Kingdom Inflation.”.Econometrica,987–1007

  • Olson, E., Andrew Vivian, & Wohar, M. E. (2019). What is a better cross-hedge for energy: Equities or other commodities?Global Finance Journal

  • Fakhfekh, M., Jeribi, A., Ghorbel, A., & Hachicha, N. (2021). Hedging stock market prices with WTI, Gold, VIX and cryptocurrencies: a comparison between DCC, ADCC and GO-GARCH models. International Journal of Emerging Markets. doi:https://doi.org/10.1108/IJOEM-03-2020-0264

    Article  Google Scholar 

  • Floros, C. (2006). &. Hedging effectiveness in Greek stock index futures market 1999–2001.International Research Journal of Finance and Economics,7–18

  • Floros, C., & Vougas, D. (2006). Hedging effectiveness in Greek stock index futures market, 1999–2001.International Research Journal of Finance and Economics,7–18

  • Futures Industry Association (2021). Futures Industry Association (FIA). Retrieved from https://www.fia.org/resources/global-futures-and-options-trading-hits-another-record-2021

  • Geppert, J. M. (1995). A statistical model for the relationship between futures contract hedging effectiveness and investment horizon length: introduction (1986–1998). The Journal of Futures Markets

  • Goknur Buyukkara, C. C. (2021). Optimal hedge ratios and hedging effectiveness: An analysis of the Turkish futures market.Borsa Istanbul Review

  • Goyal, J., Singh, M., Singh, R., & Aggarwal, A. (2019). efficiancy and technology gaps in Indian banking sector: Application of meta-frontier directional distance function DEA approch.The journal of finance and data science,156–172

  • Gupta, K., & Kaur, M. (2015). Impact of Financial crisis on hedging effectiveness of futures contracts: Evidence from the National Stock Exchange of India.South East European Journal of Economics and Business, 69

  • Gupta, K., & Singh, B. (2009). “Estimating the Optimal Hedge Ratio in the Indian Equity Futures Market.“.IUP Journal of Financial Risk Management, 6

  • Howard, C. D. (1984). A risk-return measure of hedging effectiveness.Journal of Financial and Quantitative Analysis,101–111

  • Howard, C. T., & D’Antonio, L. J. (1994). The cost of hedging and the optimal hedge ratio.The Journal of Futures Markets,237

  • Hsu, W. C., & Lee, H. T. (2018). Cross Hedging Stock Sector Risk with Index Futures by Considering the Global Equity Systematic Risk. International Journal Financial Studies. doi:https://doi.org/10.3390/ijfs6020044

    Article  Google Scholar 

  • Huang, Y., Wenjing Su, & Li, X. (2010). “Comparison of BEKK GARCH and DCC GARCH models: An empirical study.“. International Conference on Advanced Data Mining and Applications.

  • Hull, J. C. (2003). Options Futures and Other Derivatives. India: Pearson Education

    Google Scholar 

  • In, F., & Kim, S. (2006). The Hedge Ratio and the Empirical Relationship between the Stock and Futures Markets: A New Approach Using Wavelet Analysis. The Journal of Business, 799–820. doi:https://doi.org/10.1086/499138

  • International Financial Risk Institute (2012). Retrieved from International Financial Risk Institute: http://ifci.ch/

  • Jason, L., & John Thompson. (2005). &. Hedging effectiveness of stock index futures,.European Journal of Operational Research,177–191

  • Johnson, L. (1960). The theory of hedging and speculation in commodity futures,.Review of Economic Studies,139–151

  • Jorion, P. (2007). Financial Risk Manager Handbook. United Kingdom: Wiley

    Google Scholar 

  • Kavussanos, M. G., & Nomikos, N. K. (2000). Constant vs. time varying hedge ratios and hedging efficiency in the BIFFEX market.Transportation Research Part ELogistics & Transportation Review,229–248

  • Kim, S. W. (2015). &.-S. CROSS HEDGING WINTER CANOLA.Journal of Agricultural and Applied Economics,462–481

  • Koulis, A., Kaimakamis, G., & Beneki, C. (2018). Hedging effectiveness for international index futures markets.Economics and Business,149–159

  • Kumar, B. P. (2010). Hedging Effectiveness with CNX Bank Nifty and Nifty Futures: VECH (Ht) Approach.Finance India,429–446

  • Kumar, B. P., & Supriya, M. (2010). Evaluation of Hedging Effectiveness for CNX Bank and Nifty Index Futures. Emerging Markets: Finance eJournal (2010)

  • Kumar, B., & Pandey, A. (2013). Market efficiency in Indian commodity futures markets.Journal of Indian Business Research,101–121

  • Kumar, B., Singh, P., & Pandey, A. (2008). Hedging Effectiveness of Constant and Time Varying Hedge Ratio in Indian Stock and Commodity Futures Markets. SSRN: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1206555

  • Laws, J., & Thompson, J. (2005). Hedging effectiveness of stock index futures.European Journal of Operational Research,177–191

  • Lien, D., Lee, G., Yang, L., & Zhou, C. (2015). Evaluating the effectiveness of futures hedging.Handbook of financial econometrics and statistics,1891–1908

  • Markowitz, H. M. (1959). Portfolio selection: efficient diversification of investments. New York: John Wiley and Sons, Inc

    Google Scholar 

  • Mensi, W., Beljid, M., Boubaker, A., & Managi, S. (2013). Correlations and volatility spillovers across commodity and stock markets: Linking energies, food and gold. Economic Modelling, 15–22. doi:https://doi.org/10.1016/j.econmod.2013.01.023

  • Moosa, Ripple, R. D., & Imad, A. (2007). Hedging effectiveness and futures contract maturity: the case of NYMEX crude oil futures.Applied Financial Economics,683–689

  • Movafaghi, O. (2014). Cross-Hedging Bison on Live Cattle Futures. Agriculture and Applied Economics, 1–60. Retrieved from https://vtechworks.lib.vt.edu/bitstream/handle/10919/50205/Movafaghi_OS_T_2014.pdf?sequence=1

  • Nasser, M. A., Gomez, O., & Garza, X. (2009). Do well-functioning financial systems affect the FDI flows to Latin America.International Research Journal of Finance and Economics

  • Nelson, D. (2019). Stock Market Investing for Beginners. N.p: Platinum Press LLC

    Google Scholar 

  • Olson, E., Vivian, A., & Wohar, M. E. (2017). Do commodities make effective hedges for equity investors?Research in International Business and Finance,1274–1288

  • Olson, E., Vivian, A., & Wohar, M. E. (2019). What is a better cross-hedge for energy: Equities or other commodities?Global Finance Journal

  • Omar Bassal, C. F. (2008). Swing Trading for Dummies. John Wiley & Sons

  • Onyinyechi, N., & Josephine (2010). An Analysis of Bank Credit on the Nigeria Economic Growth (1992–2008).JOS Journal of Economics,43–58

  • Park, S. Y., & Jei, S. (2010). Estimation and hedging effectiveness of timevarying hedge ratio: Flexible bivariate GARCH approaches.Journal of Futures Markets.,71–99

  • Pervez, M., Rashid, M. H., Chowdhury, M. A., & Rahaman, M. (2018). “Predicting the Stock market efficiency in weak form: A study on Dhaka Stock Exchange.“.International Journal of Economics and Financial Issues,88–95

  • Pok, W., Poshakwale, S., & Ford, J. (2009). Stock index futures hedging in the emerging Malaysian market.Global Finance Journal,273–288

  • Pradhan, K. C. (2011). The Hedging Effectiveness of Stock Index Futures: Evidence for the S&P CNX Nifty Index Traded in India.South East European Journal of Economics and Business,111–117

  • Ranajee, B. B. (2018). Factors influencing profitability of banks in India. 3406 – 3061: Theoretical Economic Letters

    Google Scholar 

  • Roca, J. A., & Hatemi, E. (2006). Calculating the optimal hedge ratio: constant, time varying and the Kalman Filter Approach,.Applied Economic Letters,293–299

  • Saadet, K., & Adnan, K. (2011). Efficiancy, productivity and stock perfomance: evdance from the turkish banking setor.Panoeconomicus,355–372

  • Sadorsky, P. (2014). Modeling volatility and correlations between emerging market stock prices and the prices of copper, oil and wheat. Energy Economics, 72–81. doi:https://doi.org/10.1016/j.eneco.2014.02.014

  • Shafer, C. E. (1993). Hedge Ratios and Basis Behavior: An Intuitive Insight? The Journal of Futures Markets, 837–847. doi: https://doi.org/10.1002/fut.3990130802

  • Singh, A., Arya, A., & Jyoti, B. (2019). a cenceptual review on economic, busiiness, intellectual proparty rights and science and technological related activities in asian economics.JNNCE Journal of Engineering and Management,1–22

  • Singleton, J. C., & Wingender, J. (1986). Skewness persistence in common stock returns.Journal of Financial and Quantitative Analysis,335–341

  • Sinha, P. C. (2019). Market microstructure noise, intraday stock market returns, and adaptive learning: Indian evidence. Colombo Business Journal, 25–74. doi:https://doi.org/10.4038/cbj.v10i2.50

  • Tsay, R. S. (2010). Analysis of Financial Time Series. Wiley

  • Wang, Y. W. (2015). Hedging with futures: Does anything beat the naïve hedging strategy?Management Science,2870–2889

  • Wen-Chung Hsu, H. T. L. (2018). Cross Hedging Stock Sector Risk with Index Futures by Considering the Global Equity Systematic Risk.International Journal of Financial studies.

  • Yan Zhipeng, & Shenghong, L. (2017). Hedge ratio on Markov regime-switching diagonal Bekk–Garch model.Finance Research Letters,1–7

  • Yang, & Joey, W. (2001). M-GARCH hedge ratios and hedging effectiveness in Australian futures markets. Available at SSRN, 259968, 32

    Google Scholar 

  • Yang, J., & Allen, D. (2005). Multivariate GARCH hedge ratios and hedging effectiveness in Australian futures markets.Accounting & Finance,301–321

  • Yang, Y. W., & Wu, C. L. (2015). Hedging with Futures: Does Anything Beat the Naïve Hedging Strategy?Management Science,2870–2889

  • Zeno Adams, M. G. (2012). Cross hedging jet-fuel price exposure.Energy Economics,1301–1309

  • Zhipeng, Y., & Shenghong, L. (2018). Hedge ratio on Markov regime-switching diagonal Bekk–Garch model.Finance Research Letters,49–55

Download references

Author information

Author notes

  1. Babu Jose

    Present address: Department of Commerce, St. Thomas College, Palai, 686573, Kottayam, Kerala, India

  2. Nithin Jose

    Present address: Department of Commerce, St. Joseph’s College (Autonomous), Devagiri, 673008, Kozhikode, Kerala, India

Authors and Affiliations

    Authors
    1. Babu Jose
      View author publications

      You can also search for this author in PubMed Google Scholar

    2. Nithin Jose
      View author publications

      You can also search for this author in PubMed Google Scholar

    Corresponding author

    Correspondence to Nithin Jose.

    Additional information

    Publisher’s Note

    Springer Nature remains neutral with regard to jurisdictional claims in published maps and institutional affiliations.

    Rights and permissions

    Springer Nature or its licensor holds exclusive rights to this article under a publishing agreement with the author(s) or other rightsholder(s); author self-archiving of the accepted manuscript version of this article is solely governed by the terms of such publishing agreement and applicable law.

    Reprints and permissions

    About this article

    Check for updates. Verify currency and authenticity via CrossMark

    Cite this article

    Jose, B., Jose, N. Is Cross-Hedging Effective for Mitigating Equity Investment Risks in the Indian Banking Sector?. Asia-Pac Financ Markets 30, 189–210 (2023). https://doi.org/10.1007/s10690-022-09383-7

    Download citation

    • Received:

    • Revised:

    • Accepted:

    • Published:

    • Issue Date:

    • DOI: https://doi.org/10.1007/s10690-022-09383-7

    Keywords

    Search

    Navigation