Bitcoin Risk Premia Across Return Tails and Volatility Regimes

Summary

The paper studies first- and second-moment risk premia in Bitcoin using option-implied information and realized returns, and compares them with those in the S&P 500. It reports that Bitcoin has greater volatility and a higher variance risk premium. A decomposition by return regions finds that moderately negative outcomes contribute a smaller share of Bitcoin’s total return premium than they do to the US equity premium.

The authors cluster estimated Bitcoin option-implied risk-neutral densities and identify two volatility regimes with different premium patterns. In low-volatility conditions, positive returns account for a relatively large share of the Bitcoin premium and the variance risk premium is higher; in high-volatility conditions, positive and negative return contributions are more balanced and the variance premium is lower. These are empirical findings from the described data and method; the excerpt gives no sample period or detail on robustness, so it does not establish how stable the patterns are across other periods or specifications.

Key ideas

• Bitcoin exhibits higher volatility and a higher variance risk premium than the S&P 500 in the study.
• The study separates return premia by regions of the return distribution.
• A clustering method applied to option-implied densities identifies two volatility regimes.
• In the low-volatility regime, positive returns contribute more to Bitcoin’s premium and the variance premium is higher.
• In the high-volatility regime, positive and negative return contributions are more balanced.

Tags

# Risk Premia in the Bitcoin Market


# Risk Premia in the Bitcoin Market









We analyze the first and second moment risk premia in the Bitcoin market based on options and realized returns and contrast them to the premia embedded in the main US stock index market. First, Bitcoin is much more volatile and has a higher variance risk premium than the S&P 500. By decomposing the return premium into different regions of the return state space, we find that while most of the S&P 500 equity premium comes from mildly negative returns, the corresponding negative Bitcoin returns (between three and one standard deviations) account for only one-third of the total Bitcoin premium (BP). Further, applying a novel clustering algorithm to a collection of estimated Bitcoin option-implied risk-neutral densities, we find that risk premia vary over time as a function of two distinct market volatility regimes. The low-volatility regime implies a relatively high share of BP attributable to positive returns and a high Bitcoin Variance Risk Premium (BVRP). In high-volatility states, the BP attributable to positive and negative returns is more balanced, and the BVRP is lower. These results suggest Bitcoin investors are more concerned about variance and upside risk in a low-volatility regime.

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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.