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Market risk and Bitcoin returns

Author

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  • Dimitrios Koutmos

    (Worcester Polytechnic Institute)

Abstract

Bitcoin is emerging as a distinct asset class among investors given its seemingly detached price behavior relative to market and economic fundamentals. Its incomparably high returns in recent years has further fuelled intense interest and investment into Bitcoin and cryptocurrencies at large. This paper cautions that Bitcoin prices, despite their seemingly attractive independent behavior relative to economic variables, may still be exposed to the same types of market risks which afflict the performance of conventional financial assets. Using a Markov regime-switching model to distinguish between regimes of high and low Bitcoin price volatility, this paper shows that while returns on the aggregate market portfolio cannot explain Bitcoin returns, other asset pricing risk factors, such as interest rates and implied stock market and foreign exchange market volatilities, are important determinants of Bitcoin returns. Distinguishing between periods of high and low Bitcoin price volatility reveals heterogeneity in the explanatory power of market risk factors; in particular, Bitcoin returns are more difficult to explain during periods of high volatility relative to periods with low volatility. This finding can partially explain why extant studies, which neglect to distinguish between exchange rate regimes in Bitcoin, have difficulty linking Bitcoin prices to economic fundamentals.

Suggested Citation

  • Dimitrios Koutmos, 2020. "Market risk and Bitcoin returns," Annals of Operations Research, Springer, vol. 294(1), pages 453-477, November.
    • Handle: RePEc:spr:annopr:v:294:y:2020:i:1:d:10.1007_s10479-019-03255-6
    DOI: 10.1007/s10479-019-03255-6
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    Cited by:

    1. Timothy King & Dimitrios Koutmos & Francesco Saverio Stentella Lopes, 2021. "Cryptocurrency Mining Protocols: A Regulatory and Technological Overview," Palgrave Studies in Financial Services Technology, in: Timothy King & Francesco Saverio Stentella Lopes & Abhishek Srivastav & Jonathan Williams (ed.), Disruptive Technology in Banking and Finance, edition 1, chapter 0, pages 93-134, Palgrave Macmillan.
    2. Erdinc Akyildirim & Oguzhan Cepni & Shaen Corbet & Gazi Salah Uddin, 2023. "Forecasting mid-price movement of Bitcoin futures using machine learning," Annals of Operations Research, Springer, vol. 330(1), pages 553-584, November.
    3. Julien Chevallier & Dominique Guégan & Stéphane Goutte, 2021. "Is It Possible to Forecast the Price of Bitcoin?," Forecasting, MDPI, vol. 3(2), pages 1-44, May.
    4. Abid, Ilyes & Bouri, Elie & Galariotis, Emilios & Guesmi, Khaled & Mzoughi, Hela, 2023. "Bitcoin vs. fiat currencies: Insights from extreme dependence and risk spillover analysis with financial markets," International Review of Financial Analysis, Elsevier, vol. 90(C).
    5. Şoiman, Florentina & Dumas, Jean-Guillaume & Jimenez-Garces, Sonia, 2023. "What drives DeFi market returns?," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 85(C).
    6. Pham, Son Duy & Nguyen, Thao Thac Thanh & Do, Hung Xuan, 2022. "Dynamic volatility connectedness between thermal coal futures and major cryptocurrencies: Evidence from China," Energy Economics, Elsevier, vol. 112(C).
    7. Florentina Șoiman & Jean-Guillaume Dumas & Sonia Jimenez-Garces, 2022. "The return of (I)DeFiX [Le rendement de (I)DeFiX]," Working Papers hal-03625891, HAL.
    8. Park, Beum-Jo, 2022. "The COVID-19 pandemic, volatility, and trading behavior in the bitcoin futures market," Research in International Business and Finance, Elsevier, vol. 59(C).
    9. Zhang, Dingxuan & Sun, Yuying & Duan, Hongbo & Hong, Yongmiao & Wang, Shouyang, 2023. "Speculation or currency? Multi-scale analysis of cryptocurrencies—The case of Bitcoin," International Review of Financial Analysis, Elsevier, vol. 88(C).
    10. Adedeji Daniel Gbadebo, 2023. "Dynamic Asymmetric Causality of Bitcoin’s Price-Volume Relation," SAGE Open, , vol. 13(4), pages 21582440231, December.
    11. Sofiane Aboura, 2022. "A note on the Bitcoin and Fed Funds rate," Empirical Economics, Springer, vol. 63(5), pages 2577-2603, November.
    12. Almeida, José & Gonçalves, Tiago Cruz, 2023. "A systematic literature review of investor behavior in the cryptocurrency markets," Journal of Behavioral and Experimental Finance, Elsevier, vol. 37(C).
    13. Dimitrios Koutmos, 2023. "Investor sentiment and bitcoin prices," Review of Quantitative Finance and Accounting, Springer, vol. 60(1), pages 1-29, January.
    14. Ahmed, Walid M.A., 2022. "Robust drivers of Bitcoin price movements: An extreme bounds analysis," The North American Journal of Economics and Finance, Elsevier, vol. 62(C).
    15. Gradojevic, Nikola & Kukolj, Dragan & Adcock, Robert & Djakovic, Vladimir, 2023. "Forecasting Bitcoin with technical analysis: A not-so-random forest?," International Journal of Forecasting, Elsevier, vol. 39(1), pages 1-17.
    16. Florentina c{S}oiman & Guillaume Dumas & Sonia Jimenez-Garces, 2022. "The return of (I)DeFiX," Papers 2204.00251, arXiv.org.

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    More about this item

    Keywords

    Asset pricing; Bitcoin; Markov switching model; Risk-return tradeoff;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors

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