Cue the volatility spillover in the cryptocurrency markets during the COVID-19 pandemic: evidence from DCC-GARCH and wavelet analysis

Onur Özdemir

doi:10.1186/s40854-021-00319-0

Abstract

This study investigates the dynamic mechanism of financial markets on volatility spillovers across eight major cryptocurrency returns, namely Bitcoin, Ethereum, Stellar, Ripple, Tether, Cardano, Litecoin, and Eos from November 17, 2019, to January 25, 2021. The study captures the financial behavior of investors during the COVID-19 pandemic as a result of national lockdowns and slowdown of production. Three different methods, namely, EGARCH, DCC-GARCH, and wavelet, are used to understand whether cryptocurrency markets have been exposed to extreme volatility. While GARCH family models provide information about asset returns at given time scales, wavelets capture that information across different frequencies without losing inputs from the time horizon. The overall results show that three cryptocurrency markets (i.e., Bitcoin, Ethereum, and Litecoin) are highly volatile and mutually dependent over the sample period. This result means that any kind of shock in one market leads investors to act in the same direction in the other market and thus indirectly causes volatility spillovers in those markets. The results also imply that the volatility spillover across cryptocurrency markets was more influential in the second lockdown that started at the beginning of November 2020. Finally, to calculate the financial risk, two methods—namely, value-at-risk (VaR) and conditional value-at-risk (CVaR)—are used, along with two additional stock indices (the Shanghai Composite Index and S&P 500). Regardless of the confidence level investigated, the selected crypto assets, with the exception of the USDT were found to have substantially greater downside risk than SSE and S&P 500.

Highlights

Triggered by the recent rapid rise in the price of cryptocurrencies such as Bitcoin, Ethereum, and Litecoin, a lively interest in research on these explosive bubbles has emerged as to whether the COVID-19 pandemic stimulated risky behaviors among financial investors
The minimum and maximum values show that the prices of those assets are not stable across different time scales, which refers to the initial question of volatile behavior in cryptocurrency markets
This period is characterized as having an extreme increase in the prices of digital assets, thereby indicating the potential for the emergence of volatility spillovers across cryptocurrency markets

Summary

Introduction

Triggered by the recent rapid rise in the price of cryptocurrencies such as Bitcoin, Ethereum, and Litecoin, a lively interest in research on these explosive bubbles has emerged as to whether the COVID-19 pandemic stimulated risky behaviors among financial investors. The minimum and maximum values show that the prices of those assets are not stable across different time scales, which refers to the initial question of volatile behavior in cryptocurrency markets. The estimates of preliminary tests suggest that the DCC-GARCH model is relevant for capturing the volatility spillovers in the cryptocurrency market during the COVID-19 outbreak.

Results

Conclusion