Risks and Returns of Cryptocurrency
Research Retrieved: December 2018
Retrieve the paper from SSRN
Cryptocurrencies are a new phenomenon in the investment world. Liu and Tsyvinski (2018) study the risk-return profile of three cryptocurrencies and provide interesting insights into the financial properties of this new asset class.
- Different risk-return profiles: Cryptocurrencies show a risk-return trade-off that differs substantially from other assets. For instance, there is hardly any return co-movement with stock market returns, traditional currencies, and macroeconomic factors.
- Evidence of momentum: Nevertheless, the returns of the studied cryptocurrencies can be predicted using standard methods in empirical asset pricing. Most importantly, the authors provide evidence on cryptocurrency momentum: Previous day returns are strong predictors of the returns on subsequent days. Moreover, weeks with strong returns predict strong future returns one to four weeks ahead.
- Investor attention matter: Furthermore, the authors find that investor attention is a strong predictor of cryptocurrency performance. By analysing google search and twitter post patterns, they find that increases in searches predict an increase in returns going forward at a horizon of one to six weeks – unless the connotation of the searches and posts is negative. However, in these cases the search volume is still predictive of future negative returns.
Meaning for Practice
The findings of this study are important for practice as they run counter to popular explanations of cryptocurrency investment properties: The authors show that the risk-return profiles of three major cryptocurrencies do not resemble stocks, currencies, or commodities. At the same time, the study provides first insight into cryptocurrency return predictability, and identifies momentum and investor attention as important return drivers.