Skewness Risk and the Cross-Section of Cryptocurrency Returns

Abstract

This paper investigates whether investors can earn higher profits by holding cryptocurrencies with lower asymmetry risk. Firstly, employing a non-parametric method of bootstrap resampling for testing, we found that the larger the market capitalization of cryptocurrencies, the more left-skewed their performance, and the smaller the market capitalization, the more right-skewed their performance, consistent with the findings of Jiang et al. (2020) in the stock market. Secondly, both portfolio-level analyses and cross-sectional regressions at the cryptocurrency level suggest a negative cross-sectional relationship between asymmetry risk and future returns in the cryptocurrency market. Additionally, we find that the prediction of skewness in the cryptocurrency market originates from idiosyncratic risk rather than systematic risk, which is inconsistent with the phenomenon found by Langlois (2020) in the stock market, where systematic skewness risk outperforms idiosyncratic risk. Finally, in addition to the risk-return tradeoff theory, the limits-to-arbitrage theory also offers some explanatory power for these results. Collectively, our findings highlight the significant role of asymmetry risk in determining cryptocurrency prices.

Keywords: Cryptocurrency, Asymmetry risk, Return predictability