Downside Market Risk: A Key Determinant of Cryptocurrency Returns

Риск синхронного падения как ключевой фактор доходности криптовалют

Aleksandr Kusliaikin ()
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Aleksandr Kusliaikin: National Research University Higher School of Economics

Ekonomicheskaya Politika / Economic Policy, 2025, issue 1, 30-55

Abstract: This paper is one of the first studies to investigate how downside market risk affects cryptocurrency returns. Based on weekly data for more than 900 cryptocurrencies from 2014 to 2018, downside market risk is considered in three different forms as it arises in the cryptocurrency market, the aggregate alternative investment market, and the stock market. The empirical part of the study employs regression analysis applied to each of three definitions of market risk. First, individual cryptocurrency betas are obtained with a rolling window approach. Second, factor portfolios are constructed based on individual betas to test factor strategies. Third, cross-sectional analysis is used to estimate risk premiums. The conclusion is that cryptocurrency returns are very sensitive to cryptocurrency market drops and insensitive to the dynamics of other financial assets. Downside market risk has a positive and significant effect on cryptocurrency returns, a result which is valid for both individual-instrument and portfolio investment. However, the effects of downside market risk for cryptocurrencies are not offset by any other risk factors, and the key conclusion to be drawn is that high cryptocurrency returns are fair compensation for elevated downside risk. A three-factor model that incorporates a downside market risk factor along with SMB and WML factors was the most useful of those considered, as it explained more than half of cross-sectional returns and surpassed other established models. These results may be useful for daily cryptocurrency trading as well as for further study of cryptocurrency returns.

Keywords: alternative investments; cryptoassets; diversification; market risk; multifactor models (search for similar items in EconPapers)
JEL-codes: G12 G15 (search for similar items in EconPapers)
Date: 2025
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