Speculation and Lottery-Like Demand in Cryptocurrency Markets

Abstract

This is the first paper that explores lottery-like demand in cryptocurrency markets. Since recent research provides evidence that cryptocurrency returns are rather short-memory processes in their nature, we modify Bali et al.’s (2011, 2017) MAX measure and employ a weekly forecast horizon and last week’s daily log-returns for calculating the metric for our portfolio sorts. From an econometric point of view, this study proposes statistical tests that are robust to unknown dynamic dependency structures in the cryptocurrency data. Our results show that average raw and risk adjusted return differences between cryptocurrencies in the lowest and highest MAX deciles exceed 1.50% per week. These results are robust to controls for Bitcoin risk or potential microstructure effects. Our findings are important also from a theoretical point of view because they suggest that parallel to the stock markets, similar behavioral mechanisms of underlying investor behavior are present also in new virtual currency markets.

Keywords: MAX, lottery-like demand, cryptocurrency, Financial Technology, FinTech, gambling

JEL Classification: G01, G21, G30, G32