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Dynamic volatility modelling of Bitcoin using time-varying transition probability Markov-switching GARCH model

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  • Tan, Chia-Yen
  • Koh, You-Beng
  • Ng, Kok-Haur
  • Ng, Kooi-Huat

Abstract

Bitcoin (BTC), as the dominant cryptocurrency, has attracted tremendous attention lately due to its excessive volatility. This paper proposes the time-varying transition probability Markov-switching GARCH (TV-MSGARCH) models incorporated with BTC daily trading volume and daily Google searches singly and jointly as exogenous variables to model the volatility dynamics of BTC return series. Extensive comparisons are carried out to evaluate the modelling performances of the proposed model with the benchmark models such as GARCH, GJRGARCH, threshold GARCH, constant transition probability MSGARCH and MSGJRGARCH. Results reveal that the TV-MSGARCH models with skewed and fat-tailed distribution predominate other models for the in-sample model fitting based on Akaike information criterion and other benchmark criteria. Furthermore, it is found that the TV-MSGARCH model with BTC daily trading volume and student-t error distribution offers the best out-of-sample forecast evaluated based on the mean square error loss function using Hansen’s model confidence set. Filardo’s weighted transition probabilities are also computed and the results show the existence of time-varying effect on transition probabilities. Lastly, different levels of long and short positions of value-at-risk and the expected shortfall forecasts based on MSGARCH, MSGJRGARCH and TV-MSGARCH models are also examined.

Suggested Citation

  • Tan, Chia-Yen & Koh, You-Beng & Ng, Kok-Haur & Ng, Kooi-Huat, 2021. "Dynamic volatility modelling of Bitcoin using time-varying transition probability Markov-switching GARCH model," The North American Journal of Economics and Finance, Elsevier, vol. 56(C).
    • Handle: RePEc:eee:ecofin:v:56:y:2021:i:c:s1062940821000164
    DOI: 10.1016/j.najef.2021.101377
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    3. Amaro, Raphael & Pinho, Carlos & Madaleno, Mara, 2022. "Forecasting the Value-at-Risk of energy commodities: A comparison of models and alternative distribution functions," Applied Econometrics, Russian Presidential Academy of National Economy and Public Administration (RANEPA), vol. 65, pages 77-101.
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    6. Walid Chkili, 2021. "Modeling Bitcoin price volatility: long memory vs Markov switching," Eurasian Economic Review, Springer;Eurasia Business and Economics Society, vol. 11(3), pages 433-448, September.

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    More about this item

    Keywords

    Bitcoin; Volatility; Time-varying transition probability; Markov-switching; GARCH model;
    All these keywords.

    JEL classification:

    • C01 - Mathematical and Quantitative Methods - - General - - - Econometrics
    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)

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