Upside and Downside Risk Spillovers between Cryptocurrencies and Stock market : Introducing New Cryptocurrencies using a VaR-CoVaR Approach

Abstract

This work delves into the intricate relationship between cryptocurrencies and the stock market, focusing on both Upside and Downside risk spillovers. By employing a VaR-CoVaR methodology through copulas inspired by Reboredo (2016), we aimed to understand the systemic risk linking both markets. We used an event-driven approach, with specific emphasis on key periods and events between 2019 and 2023, such as the global Covid-19 pandemic, the Ukraine war, and notable crypto-centric events like the Altcoin and BTC rallies. In a significant deviation from previous studies, we also included Altcoins, discovering unique characteristics in their interaction with stock indices compared to mainstream cryptocurrencies. Our findings underscore a dominant one-way interconnectedness, with cryptocurrencies largely transmitting both upside and downside risks to stock indices, the downside risks often being more pronounced. This discovery has profound implications for both investors and policymakers, highlighting the potential vulnerabilities in the traditional stock market tied to the behavior of digital currencies. Interestingly, the study also revealed occasional spillovers from stock indices to cryptocurrencies during extreme market conditions, indicating a more nuanced relationship that might change based on prevailing market conditions and specific events. Given the unique market behaviors and risk transmissions exhibited by these assets, our findings also suggest that cryptocurrencies offer complex diversification and hedging properties, requiring nuanced strategies and important due diligence on each cryptocurrency. It also recommends continued exploration and monitoring, especially as the integration of cryptocurrencies within traditional markets deepens, presenting new challenges and opportunities and highlighting an exciting time ahead in the interplay between these two markets.