Do cryptocurrencies and crude oil influence each other? Evidence from wavelet-based quantile-in-quantile approach

Abstract

This study investigates the asymmetric shock transmission mechanisms between seven large cryptocurrencies and crude oil at different market conditions across time. Wavelet technique was used to decompose the daily return series of the assets into wavelet scales to capture trading horizons. We applied quantile regression (QR) and quantile-in-quantile Regression (QQR) on the decomposed series to capture the bear (bull) market conditions. Applying the QR, we found Ethereum, Steller, Ripple and Monero as hedges for oil market volatility at all market regimes from medium to long terms. The QR undermined the hedging properties of Bitcoin, Litecoin and Das, suggesting possible spread of market disruptions from these markets to crude oil market. We observe from QQR that the assets have negative influence on each other at bear market but positive influence at bull market across time, signifying hedging possibilities for both assets in bear market. The significance of our finding is strengthened by the recent rise in the market share of cryptocurrencies.

Keywords:

• Cryptocurrencies
• crude oil
• asymmetric effects
• MODWT
• quantile-in-quantile regression

JEL classification:

• C38
• C58
• E49

PUBLIC INTEREST STATEMENT

Crude oil is a strategic and essential commodity for investors and the global economy. It is the primary export of most countries. Notably, an economy’s inflation and general price movement is measured by movements of crude oil price suggesting crude oil price as the harbinger of inflationary conditions in economies. Studies have demonstrated that crude oil price is the major cause of cost and demand pressures in an economy and that the price of cryptocurrencies may appreciate (depreciate) when the general price level change due to fluctuations in crude oil price. This shows the importance of investigating the dynamic interdependences between cryptocurrencies and crude oil returns at different market regimes in a time-frequency space to uncover the shock transmission mechanisms between the assets across time. The choice of cryptocurrencies and crude oil is not arbitrary but because crude oil is a major commodity traded in commodity exchanges and there has also been a creation of blockchain platform which facilitate crude oil trade between firms in the commodity industry. Importantly, crude oil price drives the price formation of cryptocurrencies therefore the response of cryptocurrencies to crude oil price shocks is crucial for risk management and assets allocation.

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1. https://www.coindesk.com/blockchain-oil-trading-platform-backed-by-shell-and-bp-is-now-live.

2. The heterogeneous market hypothesis propounded by Müller et al. (1993) argues that economic agents in financial markets are not homogeneous, all possesses the same information and objectives and thus operates at the same time and frequency.

3. Given the sample size of 877 observations and maximum scale number of decomposition possibility of $\left[Lo{g}_2\left(N\right)\right]$ ², where $N$ is the number of observations, we could have decomposed the series into nine details and one smooth component.

4. Based on the definitional approach conducted by Kaul and Sapp (2006), Baur and Lucey (2010), Reboredo (2013) and Baur and Lucey (2010), the distinctive characteristics of an asset as a safe haven, hedge and diversifier is as follows: An asset is a hedge if it exhibits a negative correlation in normal states. An asset is a safe haven if it is negatively correlated with another asset in times of market turmoil. An asset is a diversifier if it is positively but weakly correlated with another asset on average.

Additional information

Funding

The authors received no direct funding for this research.

Notes on contributors

Seyram Pearl Kumah

DR. SEYRAM PEARL KUMAH is a Lecturer in Accounting and Finance at the Akenten Appiah-Menka University of Skills Training and Entrepreneurial Development, Kumasi, Ghana. She is also a chartered accountant with 13 years’ experience in Auditing, Financial Accounting and Management Accounting practices.

Prof. Jones Odei-Mensah PROF. JONES ODEI-MENSAH is a senior faculty member at the University of the Witwatersrand, where he directs the Wits Business school’s Postgraduate Diploma in Management programme. Jones consults with multilateral organisations such as the African Export-Import Bank and the African Union; multinational professional services networks such as KPMG; think tanks such as the African Center for Economic Transformation; serves as a Board member on a few organisations, including the AREF Consult and Nile Valley Group. growth, and policy stabilisation. In recognition of his research impact, the National Research Foundation (NRF) awarded him a Y2 rating in January 2022.