This study examines the prediction power of market liquidity (the ease with which asset are traded) and funding liquidity (the ease with which traders can obtain funding) on the price volatilities of Bitcoin. We find that both market and funding liquidity shocks forecast future volatility. More importantly liquidity shocks have a stronger and persistent effect on the long-term trend component of volatility. Exploiting the predictability of liquidity shocks we propose a risk-managed strategy to manage extremely high volatility and avoid occasional large crashes in cryptocurrency markets. This novel strategy virtually eliminates crashes and improves the Sharpe ratio substantially against the benchmark buy-and-hold strategy. The outperformance is much stronger during the turbulent periods of cryptocurrencies. Hence this paper provides important insights into cryptocurrency investment and portfolio management combining traditional assets and cryptocurrencies.
Liquidity shocks ; Price volatilities ; Risk-managed trading strategy ; Cryptocurrencies (search for similar items in EconPapers)
Journal of Multinational Financial Management 2022 vol. 64 issue C