Can diversification be improved by using cryptocurrencies? Evidence from Indian equity market

Abstract

Purpose This study aims to investigate the possibilities of cryptocurrencies as hedges and diversifiers in the Indian stock market before and during financial crisis due to the pandemic and the Russia–Ukraine war. Design/methodology/approach Researchers have used daily data on cryptocurrencies and Indian stock prices from March 10, 2015 to August 26, 2022. The researchers have used the dynamic conditional correlations (DCC)-GARCH model to determine the volatility spillover and dynamic correlation between stocks and digital currencies. Further, researchers have explored hedge ratio, portfolio weight and hedging effectiveness using the estimates of the DCC-GARCH model. Findings The findings indicate a negative conditional correlation between equities and cryptocurrencies before the crisis and a positive conditional correlation except for Tether during the crisis. Which implies that cryptocurrencies serve as a hedging asset in the stock market before a crisis but are not more than a diversifier during the crisis, except for Tether. Notably, Tether serves as a safe haven during times of crisis. Finally, the study suggests that Bitcoin, Ethereum, Binance Coin and Ripple are the most effective diversifiers for Indian stocks during the crisis. Originality/value This study makes several contributions to the existing literature. First, it compares the hedge and diversification roles of cryptocurrencies in the Indian stock market before and during crisis. Second, the study findings provide insights on risk hedging and can serve as a guide for investors. Third, it may help rational investors avoid underestimating risk while constructing portfolios, particularly in times of financial turmoil.