Financial Bubbles: A Study of Co-Explosivity in the Cryptocurrency Market

Abstract

Cryptocurrencies have recently captured the interest of the econometric literature, with several works trying to address the existence of bubbles in the price dynamics of Bitcoins and other cryptoassets. Extremely rapid price accelerations, often referred to as explosive behaviors, followed by drastic drops pose high risks to investors. From a risk management perspective, testing the explosiveness of individual cryptocurrency time series is not the only crucial issue. Investigating co-explosivity in the cryptoassets, i.e., whether explosivity in one cryptocurrency leads to explosivity in other cryptocurrencies, allows indeed to take into account possible shock propagation channels and improve the prediction of market collapses. To this aim, our paper investigates the relationships between the explosive behaviors of cryptocurrencies through a unit root testing approach.

Tail Risk Measurement in Crypto-Asset Markets

“…Thus, XLM can be viewed as a bridge between the two clusters. The evidence of two clusters with highly correlated features around ETH and BTC corroborates with the results by Bouri et al (2019) and Agosto and Cafferata (2020). From an economic viewpoint, this confirms the different nature of the two groups of crypto assets with (ETH, TRX, XRP) constituting the "professional/technical" assets, while (BTC, EOS, LTC) forms the "speculative" cryptocurrencies.…”

“…The above considerations suggest that tail risk is to be taken into account, in the calculation of both systematic and systemic risk measures for crypto assets, in line with our proposed methodology, and consistently with what remarked by Bouri et al (2019) and Agosto and Cafferata (2020) in the context of price bubble determination. In the next subsection, we show our main empirical findings.…”

“…To place our findings in existing studies, the evidence of a negative systemic effect of the tail risk of Bitcoin on other cryptocurrencies confirms the results in Agosto and Cafferata (2020); Bouri et al (2019) and Borri (2019), which suggests that Bitcoin acts as a safe haven for "diversification" purposes in the crypto market. The positive systemic impact of ETH makes it serve a "complementary" role.…”

“…Most crypto assets exhibit values which reflects the non-Gaussian and heavy tailed behaviour of their associated distribution. This is particularly true for XLM and XRP, as already noted by Agosto and Cafferata (2020) .…”

“…To exemplify our proposal, we consider the leading assets from the crypto-asset market, thereby also extending the recent work of Borri (2019), who used CoVaR to show that crypto assets are highly exposed to tail risk from their market, but not from traditional assets. Our work is related to a recent research line that aims to explain bubbles in crypto prices in terms of interconnectedness between them or between exchange markets: (see for example Agosto and Cafferata, 2020;Bouri et al, 2019;Corbet et al, 2018;Giudici et al, 2019). Our work presents a more general methodology aimed at combining systemic interconnectedness with tail risk (which is indeed related to bubbles).…”