Mutual coupling between stock market and cryptocurrencies

Area of Science:

• Financial economics
• Time series analysis
• Cryptocurrency markets

Background:

• The relationship between traditional financial markets and cryptocurrencies is increasingly important.
• Understanding market interconnectedness is crucial for risk management and policy.
• Cryptocurrencies are often touted for diversification and hedging properties.

Purpose of the Study:

• To analyze the short- and long-run dynamic relationships between the U.S. S&P500 index and the returns of the top five cryptocurrencies (Bitcoin, Ethereum, Ripple, Binance, and Tether).
• To investigate causality and spillover effects between these markets.
• To assess whether cryptocurrencies fulfill their hedging and diversification roles against traditional markets.

Main Methods:

• Employed General-to-specific Vector Autoregression (GETS VAR) and traditional Vector Autoregression (VAR) models.
• Utilized Granger causality tests and cumulative impulse-response functions.
• Applied the Diebold and Yilmaz (DY) spillover index for variance decomposition.

Main Results:

• S&P500 returns exhibit positive short- and long-run effects on Bitcoin, Ethereum, Ripple, and Tether returns.
• Cryptocurrency returns generally show negative short- and long-run effects on S&P500 returns.
• S&P500 returns have a higher spillover intensity on crypto returns than vice versa, challenging diversification claims.

Conclusions:

• There is a significant bi-directional causality and mutual coupling between the S&P500 and major cryptocurrencies.
• Cryptocurrencies do not appear to serve as effective hedges against S&P500 market movements during the study period.
• Findings underscore the need for regulatory oversight to mitigate financial contagion risks from the crypto market.