Risk Premiums in the Cryptocurrency Market

Abstract

We examine the relationship between cryptocurrencies and the stock market to find out whether risk premiums exist in the cryptocurrency market. A double-sorted portfolio strategy that buys cryptocurrencies with the highest exposure to the stock market - high exposure to the market returns and low exposure to the market return volatility - and shorts cryptocurrencies with the lowest exposure to the stock market - low exposure to the market return and high exposure to the market return volatility - generates an excess return of 50% annually after surviving borrowing and trading costs. Exposure to the stock market using the principal component analysis of equity market returns and volatility produces monotonic returns and a long-short strategy return of more than 85% annually. We propose a reduced-form model that considers cryptocurrencies as levered assets on the equity market and provides evidence that investors have since 2018 employed coins in portfolio strategies which in turn have created a connection between the two markets.

JEL Classification: C8, G10, G12