VCRIX - A Volatility Index for Crypto-Currencies

Abstract

Public interest, explosive returns, and diversification opportunities gave stimulus to the adoption of traditional financial tools to crypto-currencies. While the CRIX offered the first scientifically-backed proxy to the crypto-market (analogous to S&P 500), measuring the forward-oriented risk in the crypto-currency market posed a challenge of a different kind. Following the intuition of the "fear index" VIX for the American stock market, the VCRIX volatility index was created to capture the investor expectations about the crypto-currency ecosystem. VCRIX is built based on CRIX and offers a forecast based on the Heterogeneous Auto-Regressive (HAR) model. The HAR model was selected as the most suitable out of a horse race of volatility models, with two proxies for implied volatility, namely the 30 days mean annualized volatility and realized volatility. The model was further examined by the simulation of VIX (resulting in a correlation of 78% between the actual VIX and a "VIX" version estimated with the VCRIX technology). Trading strategies confirmed the predictive power of VCRIX and supported the selection of the 30 days means annualized volatility proxy. The best performing trading strategy with the use of VCRIX outperformed the benchmark strategy for 99.8% of the tested period and 164% additional returns. VCRIX provides forecasting functionality and serves as a proxy for the investors' expectations in the absence of a developed crypto derivatives market. These features provide enhanced decision making capacities for market monitoring, trading strategies, and potentially option pricing.

Keywords: index construction, volatility, crypto-currency, VCRIX

JEL Classification: C51, C52, C53, G10