Forecasting returns of major cryptocurrencies: Evidence from regime-switching factor models

Abstract

The returns of cryptocurrencies tend to co-move, with their degree of co-movement being contingent on the (bullish- or bearish-) states. Given this, we use standard factor models and regime-switching factor loadings to forecast the returns of a specific cryptocurrency based on its lagged information and informational contents of 14 other cryptocurrencies, with these 15 together constituting 65% of the market capitalization. Considering top five cryptocurrencies namely, Bitcoin, Ethereum, Ripple, Dogecoin, and Litecoin, we find significant forecastability and evidence that factor models, in general, outperform the benchmark random-walk model, with the regime-switching versions standing out in the majority of the cases.