Common risk factors in the returns on digital assets: evidence from cryptocurrency market

Abstract

Introduction. Digital financial assets are a relatively new phenomenon. More and more, they include virtual currencies, and in particular cryptocurrencies. Both regulators and financial market players are becoming increasingly interested in such assets. Cryptocurrencies have no intrinsic value, and this encourages scientific studies on the problem of price formation and risk management associated with cryptocurrency operations. Most papers on the problem lack a systematic ap-proach and do not provide solutions to a large number of fundamental issues.
 Purpose. The purpose of our study was to develop a method for the risk analysis of operations with digital financial assets, namely cryptocurrencies.
 Methodology. In our study, we used parametric methods of data analysis and ma-chine learning methods, description, analysis, synthesis, induction, deduction, comparison, and grouping method. The sample was accumulated between April 2013 and April 2021 and included cryptocurrencies with the market capitalization of over 1 million USD.
 Results. The study determined the common risk factors for the cryptocurrency market. The risk factors are presented as linear combinations of returns of subsets of cryptocurrencies with dynamically changing weight coefficients. The risk factors were formed based on the market information, which included the price of the cryptocurrency, the trading volume, and its market capitalization.
 Conclusions. The study demonstrated that the cryptocurrency market is suscepti-ble to market anomalies common to traditional financial asset markets. In addition to the risk factors based on the market capitalization of cryptocurrencies (the size) and their aggregate profitability (the momentum), the article presents statistically relevant risk factors which reflect the growth rate of the market capitalization and the level of illiquidity of cryptocurrencies. In order to explain the market anomalies and the arbitrary strategies based on them, the article presents several factor models of cryptocurrency price formation. These models can be used to develop an in-tegrated approach to the risks associated with operations with digital financial assets.