Abstract

The legitimacy of virtual currencies as an alternative form of monetary exchange has been the centre of an ongoing heated debated since the catastrophic global financial meltdown of 2007–2008. Our study tests the informational market efficiency of cryptomarkets by investigating the weak-form efficiency of the top-five cryptocurrencies using random walk testing procedures which are robust to asymmetries and unobserved smooth structural breaks. Moreover, our study employs two frequencies of cryptocurrency returns, one corresponding to daily returns and the other to weekly returns. Our findings validate the random walk hypothesis for daily series hence validating the weak-form efficiency for daily returns. On the other hand, weekly returns are observed to be stationary processes which is evidence against weak-form efficiency for weekly returns. Overall, our study has important implications for market participants within cryptocurrency markets.

Highlights

  • The role of cryptocurrencies as an alternative decentralized monetary system has gained a lot of traction following the disastrous sub-prime financial crisis of 2007–2008 which retarded the global financial system at levels not experienced since the infamous ‘Great Recession’ period of the 1930's

  • Our study employs flexible Fourier form (FFF) unit root testing procedure described in Enders and Lee (2012) which is robust to asymmetries and unobserved structural breaks which are likely to exist in high frequency financial series such cryptocurrency prices and returns

  • Our study employs two ‘non-conventional’ unit root testing procedures, the first being the Kapetanois et al (2003) exponential smooth transition autoregressive (ESTAR) unit root testing procedure which is robust to asymmetries, and second the flexible Fourier form (FFF) testing procedure described in Enders and Lee (2012) which is robust to asymmetries and smooth structural breaks

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Summary

Introduction

The role of cryptocurrencies as an alternative decentralized monetary system has gained a lot of traction following the disastrous sub-prime financial crisis of 2007–2008 which retarded the global financial system at levels not experienced since the infamous ‘Great Recession’ period of the 1930's. The role of blockchain technology in reshaping traditional financial markets as well as the innovative potential of this technology in solving some of the recurrent socio-economic problems, in developing countries characterized by unstable monetary and fiscal policies, financial exclusion, extreme poverty and high corruption levels, cannot be understated (Weber, 2016). This innovation can only be enhanced by mitigating the risks that come with it since digital currency markets are rife with speculation. The empirical results are presented in the fifth section of the paper whilst the study is concluded in the sixth section

Cryptocurrencies as a decentralized monetary system
Review of the associated literature
The random walk model of asset returns
Testing the random walk using the KSS nonlinear unit root
Testing the random walk via flexible fourier functions
Empirical data and descriptive statistics
Preliminary unit root tests
Second generation unit root tests
FFF-unit root test results
Conclusions
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