HSE Found Out: The Cryptocurrency Market Operates According to the Same Laws as the Stock Market, But Much Faster

(ORDO NEWS) — After analyzing the price changes of almost 2,000 cryptocurrencies over the course of seven years, Victoria Dobrynskaya, Associate Professor at the Faculty of Economic Sciences at the Higher School of Economics, found that there are no fundamental differences in the behavior of familiar assets and cryptocurrencies.

It obeys the same laws, but prices change much faster: those processes that take a year in traditional markets take about a month in the cryptocurrency market.

The preprint of the article is published on the SSRN website. Financiers are aware of two patterns that link asset prices over the past and future periods: the momentum effect (if the prices of securities that have risen in the past continue to rise further) and the reverse reversal effect (when investing in stocks that have recently become profitable becomes profitable) cheaper).

Numerous studies confirm that in the stock market the first of them is noticeable in the short term (up to a year), and the second – with longer periods (1–5 years).

The question of whether these patterns manifest themselves in the cryptocurrency market and whether their action differs from that observed in the traditional securities markets is still open: some economists find a momentum effect in the short term, others note that it exists, but is not significant, and others do not indicate a reversal effect in the short term.

Such different results are obtained because the studies use different (often small) samples of cryptocurrencies, different periods of time and strategies are considered.

Victoria Dobrynskaya collected data on price changes for all cryptocurrencies with a capitalization of more than one million dollars (there were about 2,000 of them at the end of 2020).

The Economist reviewed a variety of momentum strategies with holding periods from 1 to 12 weeks and past returns from one week to two years. The period for which the data was collected begins with the rise of the popularity of cryptocurrencies and covers 2014-2020.

“To date, this study is the most comprehensive, as it considers a large number of different specifications of momentum strategies, they are applied to all major cryptocurrencies with a capitalization of more than one million dollars and cover almost the entire history of the cryptocurrency market.

In addition, this is the first scientific work that considers the specifications of momentum strategies with cryptocurrencies holding periods of more than one month,” the author of the work noted.

Momentum portfolios are formed as follows: cryptocurrencies are ranked based on profitability data for some past period (from one week to two years), an investor buys 30 percent of the most profitable and sells 30 percent of the least profitable cryptocurrencies, and for some time (from one week to three months) keeps the resulting set with him. After that, the procedure is repeated, the composition of the portfolio changes.

The results showed that if such a portfolio is rebalanced frequently (every week), then its profitability depends on the period based on which cryptocurrencies were ranked and on the holding period, and this dependence is inverse: the longer these periods are, the less profitable the investment is, and starting from a period of four weeks, such portfolios become unprofitable (that is, there is a reversal effect).

At the same time, the difference in returns is very large: from 70 percent per annum with a ranking and holding period of two weeks to about 1,000 percent per annum with a ranging period of 1–2 weeks and a holding period of 10–12 weeks.

“We are seeing a very strong reversal effect in the long run. Moreover, the long-term period in the cryptocurrency market begins much earlier than in traditional financial markets – after a month. It also testifies to the “high metabolism of cryptocurrencies” that many economists talk about,” commented Victoria Dobrynskaya.

However, as the author of the article notes, the weekly buying and selling of cryptocurrencies to rebalance the portfolio is associated with significant transaction costs, and in practice, strategies with longer terms will be more rational.

The author shows that if the portfolio is audited less frequently (every 2–8 weeks), then the dependence will be similar. The maximum momentum effect is observed with a sorting, holding and rebalancing period of two weeks, and as these periods increase, returns fall, and we observe a reversal effect starting from 4–6 weeks.


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