Examining the volatility spillover in leading cryptocurrencies and investigating the hedge/safe haven properties of Ethereum

Abstract

Purpose: This paper investigates the interconnectedness of the five largest cryptocurrencies in terms of market capitalization namely, Bitcoin, Ethereum, Ripple, Bitcoin Cash and Litecoin through a volatility spillover inspection. It also studies the hedging and/or safe haven capabilities of Ethereum, the second largest cryptocurrency in terms of market capitalization, against the main conventional currencies and the traditional assets in the United States and the European markets. Design/methodology/approach: In the first part of the research, univariate general autoregressive conditional heteroskedasticity (GARCH) techniques are used to model the volatility of the return series of the cryptocurrencies. Vector autoregressive model (VAR) is then used to examine if volatility spillovers exist between the selected cryptocurrencies. The data retrieved from a reliable website spans from August 2017 until December 2019 with a total of 870 observations. However, in the second part of the research, Ethereum’s capability as a hedging and/or safe haven tool in an investor’s portfolio is examined using ordinary least squares regressions with percentiles. Crisis event interaction regressions are also performed as a robustness check. We selected three worldwide events that have caused financial turmoil in the market, namely the US presidential election of 2016, the Brexit referendum and the covid-19 to confirm the results of the percentile regressions. The hedging and/or safe haven capability of Ethereum is checked against the US and EU stock markets, the US and EU bond markets, the crude oil and the gold. The return series are retrieved from Thomson Reuters Eikon. For the US market, the data spans from March 2016 until May 2020 with a total of 843 observations while for the EU market, the data spans from March 2016 until May 2020 with a total of 852 observations. Findings: In the first part of the research, the findings reveal the existence of volatility spillovers between the cryptocurrencies. More particularly, Bitcoin is the most prominent transmitter of volatility shocks followed by Litecoin while Ripple is the top receiver of volatility shocks followed by Litecoin and Ethereum. Additionally, Bitcoin is mainly affected by its own shocks whereas Ethereum, Ripple, Bitcoin Cash and Litecoin are affected by both their own shocks and by shocks from other cryptocurrencies. Moreover, the results show that there are uni-directional volatility spillovers from Bitcoin to Ethereum, Ripple, Bitcoin Cash and Litecoin, uni-directional volatility spillovers from Ethereum to Litecoin and uni-directional volatility spillovers from Litecoin to Ripple. In the second part of the research, the results reveal that Ethereum does not act as a hedging and/or safe haven asset against the traditional currencies, the US and EU stock markets, the US and EU bond markets, the crude oil and the gold. These results are confirmed in the crisis event interaction model. However, Ethereum seems to act as a safe haven only in some specific events that caused financial turmoil in the market. In this study, during the Brexit referendum event, Ethereum did act as a safe haven against extreme movements in the European bonds. Practical implications: Our results may be of great help for investors. The results of the research may help them manage the risks of their portfolios since cryptocurrencies are interlinked and volatility spillovers exist among them. Our findings also help investors better understand the behavior of Ethereum. They reveal to investors that Ethereum does not act as a hedge and/or a safe haven in their portfolios against the conventional foreign exchange currencies, the US and EU stock markets, the US and EU bond markets, and the main traded commodities such as the crude oil and the gold. Thus, they should privilege other assets if they want to hedge the risks in their portfolios. Originality/value: The importance of cryptocurrencies as an alternative asset class has gained a great attention in the financial market in the last decade since the invention of Bitcoin in 2009. Many studies have been performed on the interconnectedness of cryptocurrencies and their interrelation with the traditional assets. Yet, to the best of our knowledge, studies examining volatility spillovers of cryptocurrencies using GARCH- VAR models are still rare. Moreover, most of the researches that study the hedging and/or safe haven potential of cryptocurrencies against traditional assets have focused on Bitcoin, the most prominent cryptocurrency in terms of market capitalization. Very few studies have considered investigating the same properties for Ethereum. Our thesis fills this gap by examining these properties for Ethereum, the second largest cryptocurrency in terms of market capitalization, to date.