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BitCoin’s Roller Coaster: Systemic Risk and Market Sentiment

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BitCoin’s Roller Coaster: Systemic Risk and Market Sentiment

Panagiota K. Makrichoriti

Athens University of Economics and Business – Department of Accounting and Finance

George Moratis

Athens University of Economics and Business

July 11, 2016


This study investigates the determinants of Bitcoin exchange rate over the period Feb. 2013 – Apr. 2016 within a VAR framework. We are mainly driven by the narrow knowledge of this high volatile cryptocurrency’s behavior. We ask the question how and to what extent the overall credit and liquidity conditions affect Bitcoin. A novel feature of this paper is its important implications for the investors in order to understand Bitcoin’s determinants. Also, the empirical investigation is conducted by means of VAR model that permits the analysis of multi-directional relationships in a dynamic context. Our findings indicate that investor sentiment is the only important Bitcoin determinant among other factors which capture the overall economic situation, while spillover effects measured by the spillover ma- trix introduced by Diebold and Yilmaz (2009) indicate that Bitcoin appears to be a “lonely boat” that is mostly affected by “idiosyncratic” factors. Hence, it is very important for in- vestors to gain knowledge on Bitcoin’s special characteristics, while paying attention to the investors sentiment.

1 Introduction As Arthur C. Clarke1 said “two possibilities exist: either we are alone in the Universe or we are not. Both are equally terrifying.” To some extent, this quote has implications for international finance, as spillover effects and interdependence among markets transformed the financial landscape. Bitcoin exchange rates exhibit somewhat complicated dynamics and its exchange rate is not well aligned with those of other currencies. At a first glance, Bitcoin variation seems to be released by financial markets’ “leash”, as its fluctuations were going through the roof. However, the apparent opportunities that Bitcoin offers may include risks, whose nature and importance are not well understood, and affect everyone who uses Bitcoin as a currency or trades it as an asset. For instance, Graham et al. (2005) find that most executives feel they make an appropriate choice, when sacrificing economic value for smooth earnings or for hitting a target. So, how could they ever choose such a volatile vehicle, when at the same time they do not have broad knowledge of its determinants?

The biggest concern on Bitcoin is its high volatility and its sensitive price. A recent illustrative example of intense currency fluctuation is the case of euro. More precisely, until May 2008, Euro gained almost 100% against the US dollar, while during the global financial crisis it lost more than 30% of its value. However, the fluctuation on Bitcoin’s price during the period November 2013 to January 2015 is unprecedented. Bitcoin’s appreciation was almost zero in 2009; it rose to 1,163 (to USD) in November 2013 and then declined to 167 (to USD). In this setting therefore an interesting topic for research is whether Bitcoin’s intense behavior may be attributed to the general market conditions or to “idiosyncratic” factors. The present study uses monthly data covering the period from February 2013 to April 2016.

We ask the following three questions. How have the global and Euro-zone systemic risk factors affected Bitcoin? Does Bitcoin affect the general credit and liquidity conditions? Finally, does the market sentiment have an effect on Bitcoin? In this setting, the questions asked are answered within a VAR framework, on the basis of the results obtained from Forecast Error Variance Decomposition (FEVD) analyses, Impulse Response Functions (IRFs) and spillover matrix analysis (Diebold and Yilmaz, 2009), giving the opportunity to investigate not only the market anticipation of Bitcoin but also to investigate whether Bitcoin has an effect on the overall economic condition in global markets.


4 Conclusions

Bitcoin exchange rate volatility affects everybody who uses Bitcoin as a currency or trades it as an asset. Since Bitcoin’s fluctuations were going through the roof and knowledge about its determinants is narrow, the whole topic deserves attention. Is high volatility helpful for Bitcoin or not? The answer to this question could not be black or white, as it clearly depends on the perspective from which you look at it. Volatility means risk, and this potentially means bigger returns. Nevertheless, whether you are an investor, a “miner”, a merchant or a an average user, it is very important to understand the determinants of Bitcoin.

To the best of our knowledge, this is the first study that empirically investigates the determinants of Bitcoin within a VAR setting. We use a systemic risk factor and a market expectations index to decode Bitcoin’s behavior. All in all, we could say that Bitcoin’s behavior cannot be explained by variables that capture the overall economic situation and it appears to be like a “lonely boat” which is affected only by its own characteristics and investors sentiment. The general picture has important implications for Bitcoin users in order to understand Bitcoin’s “nature”. Hence, it is very important for investor to gain knowledge on Bitcoin’s special characteristics, while taking under consideration the effect of market sentiment.


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