A Cryptocurrency Risk–Return Analysis for Bull and Bear Regimes

Abstract

In this article, the authors develop a new analytical lens through which to examine the risk–return profiles of bitcoin, litecoin, ripple, and ethereum. Their focus is to understand better the price behavior of individual cryptocurrencies and their influence on one another. To achieve this, they segment each cryptocurrency’s time series of returns into disparate bull and bear regimes. They then examine the nature and extent of overlap between these regimes and whether they change over time. They also collect and plot several indicative distributed-denial-of-service attacks against the time series to investigate their possible impact on regime change episodes. Their findings shed light on previously unexplored systemic risk indicators within the cryptomarket as a whole and on the relationship between specific cryptocurrency pairs. These findings enhance the risk management toolkit for investors by revealing potential price behavior contagion patterns between cryptocurrencies pertinent to blended portfolio management. Furthermore, the authors’ approach serves as a blueprint for additional research into regime-type overlap within the cryptomarket.

TOPICS: Real assets/alternative investments/private equity, exchanges/markets/clearinghouses, financial crises and financial market history

Key Findings

• ▪ Periods of overlapping regimes increase over time. The increase indicates a rise in cryptomarket systemic risk and an associated reduction in the diversification value of a blended portfolio of cryptocurrencies.

• ▪ Bitcoin exhibits the most favorable risk measures across both bull and bear regimes, including the lowest proclivity for extreme events during bear regimes. In contrast, ripple displays the overall riskiest profile across both regime types.

• ▪ Bitcoin’s regime type has the most meaningful impact on the risk–return profile of other cryptocurrencies, namely, litecoin and ripple. However, this relationship does not hold in reverse, a likely consequence of bitcoin’s market dominance and relative maturity.