The increasing popularity of crypto-currencies as a worldwide acceptable asset class for trading, speculation and investment purpose has drawn the attention of practitioners and researchers.
Bitcoin is the most popular among all crypto-currencies available with a share of 55% (as of December 2018) crypto-currencies market capitalization worldwide. Although academic literature on Bitcoin has received a considerable amount of impetus, very little is known about the price behaviour of the same.
Despite the growing popularity, the basic fundamental features
of Bitcoin (or any cryptocurrencies) are considered to be a ‘black box’.
Bitcoin’s characteristics as a financial asset, such as fiat money, gold and
equity, are unclear. Academic studies have compared bitcoin with other assets
such as currency and gold (Baur,
Lee, & Hong, 2018; Klein,
Bitcoin has few characteristics that allow it to function as
money, such as its easy transferability and utility as a useful payment method
(not always). Its value is determined by demand–supply. However, the biggest
shortfall of Bitcoin is the absence of a guarantor unlike other fiat money
(Central Banks play the role of a guarantor).
Due to the prohibition put forth by most of the sovereign
states in using cryptocurrencies, Bitcoin lacks a reliable proponent to sustain
and expand its usage as a medium of exchange. Further, high volatile
characteristic of Bitcoin makes it a risky instrument to be considered as a
store of value as in the times of falling prices, people would prefer assets
with stable value.
Moreover, no economic fundamentals such as inflation and
trade balance are associated with the price of Bitcoin. Holders of Bitcoin do
not receive dividends or interest payments. All these aspects make it extremely
difficult to derive a fair price for the Bitcoin. This uncertainty about its
price makes it more volatile.
There has been a reasonable attempt to understand the
different characteristics of Bitcoin prices such as Bitcoin price volatility (Baek
& Elbeck, 2015; Blau,
2017). Bitcoin prices (as well as other cryptocurrencies) are known to be
highly volatile (Dwyer,
However, studies on the volatility of Bitcoins are mostly
limited to –
There is a growing literature to understand volatility
patterns of Bitcoins (see Aalborg
et al., 2018; Bouri et
al., 2018; Ji et
al., 2018). A true understanding of Bitcoin volatility patterns could
reveal more information on market efficiency, overreactions (Chevapatrakul
& Mascia, 2018) and also other aspects of Bitcoin price movements.
However, the volatility of an asset depends on the rate at
which information is flowing into the market (Balcilar
et al., 2017). The continuous arrival of new information helps in price
movements. Major news in the market could lead to sharp reactions and could
push the market temporarily unstable before the market prices adjust and reach
a relatively stable price range.
The sharp movements in the prices reveal more information
about price changes (change in fundamentals and overreactions) and can be
captured by extreme value (EV) prices such as daily high and low (Chou et
This study aims to capture the overreaction or excess
volatility in Bitcoin prices. However, most of the studies on Bitcoin
volatility use daily closing prices for the volatility estimation. In this
study, we estimate the volatility of Bitcoin prices using Open, High, Low and
Close (OHLC) prices. Our estimation is model-free and based on squared returns
of EVs. Volatility estimation based on squared returns is more robust and
reliable as argued by Balcilar et al. (2017)
and Balcilar et al. (2018).
Sudden changes in prices occur due to the overreactions by
the market participants and therefore prices bounce back after sometimes.
However, these sharp movements in Bitcoin prices are not necessarily
overreactions all the time. It could be consistent with Bitcoin fundamentals.
In that case, prices will not bounce back so quickly. We capture the
overreactions in Bitcoin prices by comparing two different measures of
First, we compute high-to-low volatility which reflects
jumps and price-reversal in Bitcoin prices. Then we compare it with
open-to-close volatility which reflects the price movements over the full
trading hours. In the absence of overreactions and instant price adjustment,
both measures of volatility will not differ and their ratio should be unity
under perfect condition (Kayal
& Maheswaran, 2018).
If the ratio goes above unity, then the volatility reflects
a significant sign of overreaction in price changes of Bitcoin. We adopt the
definition of Maheswaran et al. (2011)
and call it excess volatility. For any asset, if sharp price changes are not
supported by its fundamentals then the asset prices will exhibit excess
volatility. We assess the same for Bitcoin prices.