Summary
We investigate whether Bitcoin can hedge and diversify risk against the Euro STOXX Index, Nikkei, Shanghai A-Share, S&P 500 and the TSX Index, and the dynamics of these abilities over different sample periods and data frequencies. Pairwise GARCH process was used for daily, weekly, and monthly return data. We find that Bitcoin is an effective strong hedge for the Euro STOXX Index, Shanghai A-Share, S&P 500 and TSX, and a diversifier for Nikkei under monthly data frequency. These hedging abilities are less significant for weekly and daily frequency. Moreover, the dramatic Bitcoin price increases in 2017 are pivotal in determining its hedging abilities against the Shanghai A-Share, Euro and TSX indices.
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1. Introduction
Bitcoin has grown in both price and popularity since its introduction in 2009. On any given day, changes in Bitcoin can headline both finance and technology news. Since its introduction to the world in 2009, prices have remained under $1500.00 USD to the end of 2016. However, the buying frenzy of 2017 lead Bitcoin price to rise to over $18,000.00 USD exhibiting major volatility on its way up (Figure 1). One week after the Chicago Board of Exchange launched its Bitcoin future contract, CME, the world's largest futures exchange, is about to launch its own Bitcoin futures contract. William Dudley, the President and CEO of Federal Reserve Bank of New York is exploring the idea of creating its own digital currency. While the actual reasons for this price boom is up for debate, one common explanation known as the “Satoshi Cycle” suggests that there is a high correlation between Google searches for “Bitcoin” and the actual prices of Bitcoin (Figure 2). Figure 3 provides insight on the positive relationship between Bitcoin’s price and the number of trades occurring that signifies growing market interest.
With Bitcoin’s increased popularity, understanding how its prices are correlated with other financial assets is of interest to investors, regulators and policy makers. Is Bitcoin a valuable asset to add to the portfolio? We will investigate how Bitcoin can be used in risk management against certain equity markets. Specifically, we follow Baur and Lucey’s (2010) research witch demonstrates that an asset exhibits strong hedging features when it is negatively correlated to another asset, and exhibits diversifying features when it is positively correlated with another asset. Dyhrberg (2016a) shows that Bitcoin is uncorrelated with assets in the FTSE Index, but it is positively correlated with the dollar-euro and dollar-sterling exchange rates. Bouri et al. (2017) report that Bitcoin’s daily returns are negatively correlated to the Japanese and Asia Pacific stocks indices, but the correlations fade for weekly data. Both of these studies are based on 2010 to 2015 data. No study, to our knowledge, has investigated how the dramatic price increases in 2017 impact the hedging abilities of Bitcoin. We fill this gap by providing an up-todate analysis of Bitcoin’s hedging ability against several major equity markets. To capture the impact of 2017 price surges on the hedging abilities, we analyze the correlations with and without 2017 data.
Bitcoin daily price data from October 2010 (the earliest data available) to October 2017 was used to investigate how Bitcoin can hedge or diversify risk against the Euro STOXX Index, Nikkei, Shanghai A-Share, S&P 500 and TSX Index conditional on daily, weekly and monthly data frequencies. Firstly, we find that Bitcoin’s daily price exhibits risk-mitigating abilities for the Shanghai A-Share index; Secondly, we find Bitcoin is a strong hedge against the Euro-Index, S&P 500, Shanghai A-Share and TSX Index for monthly data through negative relationships in returns, and is a diversifier for Nikkei through a positive relationship in returns. These findings suggest that Bitcoin is more effective at hedging and diversifying against equity markets for monthly frequency than for daily and weekly data frequencies.
We employ sub-period testing with data from 2010-2016. The 2010-2016 daily result indicates that the Shanghai A-Share is negatively correlated to Bitcoin returns similar to the full sample result, therefore Bitcoin’s daily hedging ability against Shanghai A-Share does not depend on the price change in 2017. Similarly, Bitcoin’s monthly returns have a negative correlation with S&P 500 returns and a positive correlation with Nikkei returns, similar to the full sample results. However, the monthly sub-period testing for 2010-2016 no longer shows a significant negative relationship for the Euro-Index, Shanghai A-Share, or TSX Index to Bitcoin returns. This indicates that structural changes in Bitcoin’s 2017 price are pivotal in determining Bitcoin’s hedging and diversification abilities for the Euro STOXX Index, Shanghai A-Share, and TSX Index.
We contribute to the extant literature by showing that Bitcoin provides effective risk management functions under monthly data frequencies. This is the first study analyzing Bitcoin’s hedging ability using monthly data and the first analysis of the TSE and Euro index. Secondly, our sample covers a longer time period, which enables us to find that Bitcoin’s risk management abilities are more significant than the previous literature indicates. Thirdly, we provide the first study highlighting how sensitive these hedging and diversification abilities are in relation to the big price changes of 2017.
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