Are cryptocurrencies a safe haven for stock investors? A regime-switching approach

Previous research is inconclusive regarding the diversification benefit of cryptocurrency investment. Motivated by the heterogeneous agent and financial contagion models, we develop a hypothesis on state-dependent correlation between cryptocurrency and stock returns. We apply a regime-switching model of stock–cryptocurrency returns to test our hypothesis using the four most liquid cryptocurrencies. We document a dynamic stock–cryptocurrency​ correlation that is conditional on the volatility regimes of the two assets. In particular, we find that the correlation is positive and significant when both markets are under their high-volatility states, but insignificant or even negative in other volatility states. These results imply that, although cryptocurrency can serve as a hedging asset for stock investors under normal market conditions, it is far from a safe-haven asset because of its strong co-movement with the stock market during market distress. Finally, the proposed regime-switching model proves effective in portfolio risk forecasting and portfolio risk reduction, beyond the conventional GARCH-based models.