What Makes Cryptocurrencies Special? Investor Sentiment and Return Predictability During the Bubble

Abstract

We propose a crypto-specific lexicon to quantify the investor sentiment and use it to predict the cryptocurrency market returns. The new lexicon achieves better accuracy (32\% higher) than the traditional financial lexicon when applied to an out-of-sample classification setting. The empirical results reveal that investor sentiment positively predicts excess CRIX returns with a daily in(out)-of-sample $R^2$ of 2.74\% (3.15\%) without significant evidence on the return reversal. The results are robust to the inclusion of alternative sentiment indices, technical indicators, market microstructure noise, and across bubble and non-bubble periods. We further exclude the soft information interpretation of our sentiment index by showing that non-fundamental related sentiment shows stronger predictive power than that of the fundamentally related sentiment. Our findings suggest that in a market-driven by noise traders, and when there is only limited information about the fundamental value of the underlying asset, investor sentiment drives the price evolution and its impact may not reverse in a short horizon.