Cryptocurrencies and Their Relevance to Global Financial Markets

Abstract

Cryptocurrencies and blockchain technologies have been among the most widely discussed topics in academic research and practical applications in recent years. The adoption of these technologies has seen tremendous growth and is becoming increasingly relevant as a potential disrupter of many economic industries. Thus, this thesis aims to investigate the relevance of cryptocurrencies to global financial markets.

In the second chapter of this thesis, we explore the impact of Bitcoin’s risks on traditional asset classes. Our cross-asset analysis reveals that Bitcoin has positive spillover effects on risky assets but negative spillover effects on defensive assets. By examining the source of these risk transmissions, we demonstrate that U.S. companies’ increased economic exposures to blockchain and cryptocurrency technologies have exacerbated these spillovers. Our empirical findings highlight that the price fluctuations of an unregulated asset such as Bitcoin can influence the price dynamics of regulated assets.

Motivated by the findings of the second chapter, our third chapter investigates risk exposures associated with Bitcoin in equity portfolios. We show that the Bitcoin-equity dynamics intensified post-COVID-19 and provide investment practitioners with practical guidance on managing unregulated asset risks.

Finally, we turn our attention to the behavioural biases of cryptocurrency investors, drawing on the low volatility anomaly. This study investigates the differentiated pricing of jump and diffusive risks in the cross-section of cryptocurrency returns. We show that a hedged portfolio sorted on idiosyncratic diffusive risk yields a weekly return of -1.11%, suggesting the existence of a low idiosyncratic risk anomaly. Subsequently, we examine explanations for this anomaly and show that limits to arbitrage prevent arbitrageurs from correcting the mispricing. In doing so, we demonstrate that cryptocurrency investors exhibit similar biases to equity investors.