Abstract
This study examines the portfolio diversification benefits of alternative currency trading in Bitcoin and foreign exchange markets. The following methods are applied for the analysis: the spillover index method of Diebold and Yilmaz (Int J Forecast 28(1): 57–66, 2012. https://doi.org/10.1016/j.ijforecast.2011.02.006), the spillover asymmetry measures of Barunik et al. (J Int Money Finance 77: 39–56, 2017. https://doi.org/10.1016/j.jimonfin.2017.06.003), and the frequency connectedness method of Barunik and Křehlík (J Financ Econom 16(2): 271–296, 2018. https://doi.org/10.1093/jjfinec/nby001). The findings identify the presence of low-level integration and asymmetric volatility spillover as well as a dominant role of short horizon spillover among Bitcoin markets and foreign exchange pairs for six major trading currencies (US dollar, euro, Japanese yen, British pound sterling, Australian dollar, and Canadian dollar). Bitcoin is found to provide significant portfolio diversification benefits for alternative currency foreign exchange portfolios. Alternative currency Bitcoin trading in euro is found to provide the most significant portfolio diversification benefits for foreign exchange portfolios consisting of major trading currencies. The findings of the study regarding spillover dynamics and portfolio diversification capabilities of the Bitcoin market for foreign exchange markets of major trading currencies have significant implications for portfolio diversification and risk minimization.
Highlights
The detached behavior of Bitcoin price formation from economic fundamentals makes Bitcoin a significant portfolio diversification instrument for conventional and alternative investment assets with ability to withstand financial downturns
Data and descriptive This study investigates the dynamics of volatility spillover between Bitcoin markets and foreign exchange pairs denominated in six major trading currencies data for each Bitcoin index; the foreign exchange pairs consist of 1567 observations dated from September 17, 2014 to December 31, 2018
The average volatility spillover among Bitcoin markets and the foreign exchange pairs denominated in major trading currencies is 58.3% during the sampled period
Summary
The detached behavior of Bitcoin price formation from economic fundamentals makes Bitcoin a significant portfolio diversification instrument for conventional and alternative investment assets with ability to withstand financial downturns. The published research on Bitcoin has identified the varying nature of efficiency among alternative currency Bitcoin markets (Sensoy 2019). This finding is relevant for portfolio diversification, as the presence of arbitrage opportunities among alternative currency Bitcoin markets can be utilized by profit-maximizing investors to enhance portfolio returns It is important to study the varying nature of volatility spillover and portfolio diversification benefits that alternative currency Bitcoin trading can offer investors. The currency of trade for Bitcoin is an important determinant of price differences at different alternative currencies’ Bitcoin exchanges (Brandvold et al 2015), which in turn is highly likely to affect the foreign exchange rate (Narayan et al 2019). The presence of diversity among Bitcoin prices at different alternative currencies’ exchanges (Briere et al 2015; Fry and Cheah 2016) and the presence of price bubbles in the Bitcoin market (Cheah and Fry 2015; Cheung et al 2015) motivates us to investigate the volatility spillover from the Bitcoin market to the foreign exchange pairs of six major trading currencies. To date, little attention has been paid to the analysis of volatility spillover dynamics between alternative currency Bitcoin and foreign exchange markets
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