Can Bitcoin Be Used As a Hedge Against Uncertainty Towards the World’s Fiat Economy?

A group of researchers from the University of Pretoria, South Africa, examined bitcoin as a method to hedge uncertainty towards the global fiat economy. They used historical data that represented the period between March 17th, 2011 and October 7th, 2016. Global uncertainty was quantified using the first principal component of the VIXs which represents 14 developing and developed equity markets.

The researchers used wavelets to categorize bitcoin’s returns into various frequency groups. i.e. investment horizons. Afterwards, standard OLS regressions were applied which concluded that global economic uncertainty reduces bitcoin’s returns and its long term outcome. Nevertheless, due to the heavy tails of the variables, the researchers relied on quantile methods which yielded some interesting results. Quantile regressions have proven that bitcoin is currently a real hedge against global economic uncertainty, as it has shown to react in a positive matter to uncertainty at higher quantiles as well as short frequency movements of bitcoin’s returns. The researchers also used quantile-on-quantile regressions which showed that hedging is seen at short investment horizons and at upper as well as lower ends of bitcoin’s returns and uncertainty towards the global fiat economy.

 

What Does This Study Add To The Finance Literature?

This study is a valuable piece of work that makes three important contributions to the literature of finance:

1- The first contribution represents the study’s unique methodology which combines QQ regressions with the wavelets approach. Wavelets divide the time series according to several frequencies, while QQ regressions formulate not only the heterogeneous relationship that links global uncertainty to bitcoin’s returns at various points of time, but also the quantile of bitcoin’s returns, and its different frequencies, as a function that relies on the quantile of the global uncertainty index. In such a way, using QQ regressions allows the relationship between the two studied variables to vary according to their respective distribution points.

2- The second contribution is related to the fact that even though many studies have examined market uncertainty, as measured by means of VIX, in analyzing the relationship between various equities and global uncertainty or economic variables and financial assets, none of these studies have paid attention towards the influence of global uncertainty on bitcoin’s markets.

3- The third contribution emerges from the researchers’ use of a relatively broad measure for market uncertainty that covers input from 14 emerging and developed equity markets, apart from previous studies that relied solely on the US VIX as a proxy to reflect global uncertainty towards the fiat economy. When doing so, the researchers provided a wide-spectrum measure of global uncertainty which is ideal for assessment of the relationship between bitcoin’s returns and global uncertainty, while taking into consideration that bitcoin is used and traded all over the world in both developed countries ( such as Japan, USA and Europe) and developing countries (Nigeria, Pakistan and China), which makes using the US VIX a restricted choice that isn’t ideal for use on a global scale.

The findings of the research paper emphasize the importance of decomposition of bitcoin’s returns into different investment horizons and they also highlighted the essential role of utilizing estimation methods which use information derived from quantiles of both global uncertainty and bitcoin’s returns. Accordingly, apart from results that are based on conditional means, bitcoin has been proven to serve as a hedge against uncertainty, towards the global fiat economy, at extreme ends of the spectrum of global uncertainty and bitcoin’s market, but within the context of short investment horizons. Thus, we can safely say that short horizon, or short term, investment in bitcoin can help investors hedge uncertainty towards global fiat equity markets, particularly when the market is exhibiting bearish or bullish patterns and also when global uncertainty is either high or low.

The interesting results of this study add more useful conclusions to previous studies that concluded that bitcoin can exhibit some hedging characteristics against fiat commodities and equities such as the works of Bouri and Dyhrberg in 2016. However, further studies are essential to examine whether or not the reported results of this study are sensitive enough to the utilization of bitcoin data which is denominated via means of another currency other than the US Dollar.