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

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.