A Time-Varying Investigation of the Dynamic Interconnectedness between the Stock Market and Cryptocurrencies

Abstract

This study investigates the dynamic connectedness, volatility dynamics and hedging effectiveness between the Indian stock market and cryptocurrencies using daily data from March 10, 2015, to July 4, 2023. Unlike prior studies, which examine either crisis or non-crisis periods in isolation, this paper is the first to compare the effectiveness of cryptocurrency hedging in the Indian equity market both before and during crisis periods, using the asymmetric dynamic conditional correlation generalized autoregressive conditional heteroskedasticity (ADCC-GARCH) framework. The ADCC-GARCH method evaluates the conditional correlation and volatility spillovers among the returns of these asset classes over the periods. Notably, the study finds that volatility transmission is bidirectional between stock and cryptocurrency returns over time. It also determines that digital assets have the potential to act as stock market hedging assets before a crisis, but only as diversifiers during a crisis. The results from portfolio weights and hedging effectiveness demonstrate hedging benefits during crises, along with increased hedging costs during these periods. Lastly, the study finds that cryptocurrencies are poor hedging alternatives for Indian equities. This study is expected to assist investors in building low-risk portfolios, particularly during periods of economic instability.