Forecasting the Volatility of Cryptocurrencies in the Presence of COVID-19 with the State Space Model and Kalman Filter

Shafiqah Azman, Dharini Pathmanathan () and Aerambamoorthy Thavaneswaran
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Shafiqah Azman: Institute of Mathematical Sciences, Faculty of Science, Universiti Malaya, Kuala Lumpur 50603, Malaysia
Dharini Pathmanathan: Institute of Mathematical Sciences, Faculty of Science, Universiti Malaya, Kuala Lumpur 50603, Malaysia
Aerambamoorthy Thavaneswaran: Department of Statistics, University of Manitoba, Winnipeg, MB R3T 2N2, Canada

Mathematics, 2022, vol. 10, issue 17, 1-15

Abstract: During the COVID-19 pandemic, cryptocurrency prices showed abnormal volatility that attracted the participation of many investors. Studying the behaviour of volatility for the prices of cryptocurrency is an interesting problem to be investigated. This research implements the state space model framework for volatility incorporating the Kalman filter. This method directly forecasts the conditional volatility of five cryptocurrency prices (Bitcoin (BTC), Ethereum (ETH), Ripple (XRP), Litecoin (LTC) and Bitcoin Cash (BCH)) for 10,000 consecutive hours, i.e., approximately 417 days during the COVID-19 pandemic from 26 February 2020, 00:00 h until 18 April 2021, 00:00 h. The performance of this model is compared to the GARCH (1,1) model and the neural network autoregressive (NNAR) based on root mean square error (RMSE), mean absolute error (MAE) and the volatility plot. The autocorrelation function plot, histogram and the residuals plot are used to examine the model adequacy. Among the three models, the state space model gives the best fit. The state space model gives the narrowest confidence interval of volatility and value-at-risk forecasts among the three models.

Keywords: cryptocurrency; volatility; state space model; Kalman filter (search for similar items in EconPapers)
JEL-codes: C (search for similar items in EconPapers)
Date: 2022
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