Can fiat currencies really hedge Bitcoin? Evidence from dynamic short-term perspective

Abstract

Whereas much research has largely investigated the safe haven, diversifier and hedge proprieties of cryptocurrency, very few papers have analyzed the hedging issue of cryptocurrency with other assets. As such, this paper attempts to investigate the possibility if Bitcoin can be hedged by selected fiat currencies (EUR, JPY and GBP) as Bitcoin prices have experienced high and persistent volatility. To do so, we compute optimal hedge ratios between Bitcoin and fiat currencies over the period 02/02/2012–30/11/2017 based on the VAR-DCC-GARCH model, VAR-ADCC-GARCH model and VAR-component GARCH-DCC model. A rolling window analysis is employed to establish out-of-sample one-step-ahead forecasts of dynamic conditional correlations between different assets. This leads to establish time-varying hedge ratios and thus dynamic cross-hedging Bitcoin/fiat currency markets. The empirical results clearly show the time-varying correlations between Bitcoin and fiat currencies under different specifications, implying a dynamic behavior of the relationship between such assets. For all the proposed models, such dynamic correlations are rather characterized by trending downward over the period under study. The results also display time-varying hedge ratios which lead to an ongoing regular demand for rebalancing the hedged positions under different specifications. As a matter of fact, using various models which take into account different aspects of volatility and correlation structures allows to better implement dynamic hedging strategies.