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Are cryptocurrencies a safe haven for stock investors? A regime-switching approach

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  • Li, Leon
  • Miu, Peter

Abstract

Previous research is inconclusive regarding the diversification benefit of cryptocurrency investment. Motivated by the heterogeneous agent and financial contagion models, we develop a hypothesis on state-dependent correlation between cryptocurrency and stock returns. We apply a regime-switching model of stock–cryptocurrency returns to test our hypothesis using the four most liquid cryptocurrencies. We document a dynamic stock–cryptocurrency​ correlation that is conditional on the volatility regimes of the two assets. In particular, we find that the correlation is positive and significant when both markets are under their high-volatility states, but insignificant or even negative in other volatility states. These results imply that, although cryptocurrency can serve as a hedging asset for stock investors under normal market conditions, it is far from a safe-haven asset because of its strong co-movement with the stock market during market distress. Finally, the proposed regime-switching model proves effective in portfolio risk forecasting and portfolio risk reduction, beyond the conventional GARCH-based models.

Suggested Citation

  • Li, Leon & Miu, Peter, 2023. "Are cryptocurrencies a safe haven for stock investors? A regime-switching approach," Journal of Empirical Finance, Elsevier, vol. 70(C), pages 367-385.
    • Handle: RePEc:eee:empfin:v:70:y:2023:i:c:p:367-385
    DOI: 10.1016/j.jempfin.2022.12.010
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    1. Susovon Jana & Tarak N. Sahu, 2023. "Is the cryptocurrency market a hedge against stock market risk? A Wavelet and GARCH approach," Economic Notes, Banca Monte dei Paschi di Siena SpA, vol. 52(3), November.

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    More about this item

    Keywords

    Cryptocurrency; Portfolio management; Variance; Correlation; Markov-switching model;
    All these keywords.

    JEL classification:

    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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