Do collective emotions drive bitcoin volatility? A triple regime-switching vector approach

Est-ce que les émotions collectives ont une influence directrice sur la volatilité?

David Bourghelle, Fredj Jawadi and Philippe Rozin
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David Bourghelle: LUMEN - Lille University Management Lab - ULR 4999 - Université de Lille
Philippe Rozin: LUMEN - Lille University Management Lab - ULR 4999 - Université de Lille

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Abstract: In this paper, we build an empirical specification that helps to explain bitcoin volatility and to characterize phases of the bitcoin bubble using information derived from investors' emotions and sentiment that captures investment intentions and investors' aversion to risk. To this end, we investigated the bilateral relations between bitcoin volatility and investor emotions between 2018 and 2021, a period characterized by significant changes in bitcoin prices as well as wide disparities in investor emotions, especially in the context of the ongoing COVID-19 pandemic. The study was based on a linear and nonlinear Vector Autoregressive (VAR) model that we applied to data related to bitcoin prices and market sentiment as expressed by the Fear and Greed index. Overall, our results evince the key role played by collective emotions in the formation and collapse of the bitcoin bubble. Two findings in particular stand out. First, our model shows significant time-varying lead-lag effects between bitcoin volatility and investor sentiment that come into play bilaterally and help to characterize the dynamics of bitcoin volatility. Second, these interactions exhibit asymmetry and nonlinearity as the sign and size of collective emotions (resp. bitcoin volatility) vary with the regime and market state under consideration (calm state versus period of bubble formation, etc.). In other words, the power of sentiment has a time-varying effect on the market. Indeed, in the first regime ("calm state"), where bitcoin volatility is relatively low and the market shows evidence of stability, collective emotions have a negative impact on bitcoin volatility, prompting a stabilizing strength. However, in the second regime ("bubble formation"), the effect of emotions turns significantly positive as investors gradually become less fearful and more reassured, which can simultaneously increase volatility and destabilize the market. Finally, in the third regime ("bubble collapse"), when bitcoin reaches a high level of value and experiences impressive volatility excess, the effect of emotions again turns negative, resulting in further switching behavior that pushes investor action to provoke a bitcoin price correction, moving it toward a new state of stability. Our conclusion helps improve predictions of bitcoin price dynamics informed by the information provided by investor emotions.

Keywords: Bitcoin volatility; Bitcoin bubble; Emotions Sentiment; Regime-switching; VAR model Nonlinearity (search for similar items in EconPapers)
Date: 2022-04
Note: View the original document on HAL open archive server: https://hal.science/hal-04412029
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Published in Journal of Economic Behavior and Organization, 2022, 196, pp.294 - 306. ⟨10.1016/j.jebo.2022.01.026⟩

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Journal Article: Do collective emotions drive bitcoin volatility? A triple regime-switching vector approach (2022)
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Persistent link: https://EconPapers.repec.org/RePEc:hal:journl:hal-04412029

DOI: 10.1016/j.jebo.2022.01.026

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