Research Question - ECON 5029 - Methods of Economic

Research

Emmanuel Murray Leclair

2018/02/09

Professor Lynda Khalaf and Marcel Voia

Carleton University
Statement of objective
This research starts from two empirical observations in the cryptocurrency market, that of seemingly
abnormally high returns and volatility, and seek to explain it through the lenses of herding.
Motivation
Due to the decentralized and niche nature of blockchain-derived technologies, it is quite difficult to
find a homogenous set of fundamental information behind each asset. For one, cryptocurrencies do
not pay dividends and are for the most part not owned or administered by a single entity, public or
private. My hypothesis is that this lack of verifiable fundamental information could lead traders to herd,
that is form their beliefs or substitute existing beliefs based on the action of others in the market, in
analogy to a Keynesian beauty contest. There is a large theoretical literature on the subject which
links herding with anomalies such as excess volatility, mispricing, bubbles formation and crashes (A
good survey of the literature is available in [Spyrou, 2013]). The focus will thus be on the estimation
of herding behaviour rather than the theoretical underlying relationship. Following the initial idea of
[Christie and Huang, 1995], and the framework of [Hwang and Salmon, 2004], I will put emphasis on
market herding, that is herding with respect to the market consensus, defined by a weighted sum of each
assets in the market forming the market portfolio.
Expected contribution
To the best of my knowledge and after a rather extensive literature review on the subject, no other
researcher has attempted to explain the abnormally high returns and volatility of cryptocurrencies from
this perspective. [Ciaian et al., 2018] explore the idea of long-term and short-term relationship between
cryptocurrencies and Bitcoin using the usual Cointegration framework, and finds evidence of interdepen-
dency in the short run, but do not explore the dynamic evolution of this short run relationship, which
is required to observe market herding. As such, my methodology will use some of their insights but will
be strikingly different.
Additional comments
I will be looking at the dynamic evolution of the cross-sectional dispersion of each asset from the market
consensus, defined by the regression coefficient of each asset on the market portfolio (beta) in a CAPM-
like framework. The underlying idea is that there exist a time-invariant equilibrium beta parameter,
and under certain assumptions, time-variation in the beta parameter can be considered herding or anti-
herding (see [Hwang and Salmon, 2004]). This reflects the fact that there is herding if the evolution of
prices (returns) on individual assets converges towards the market consensus, which can happen in the
short run (e.g. following a large shock in the market) or in the long run.
Data
Data on prices and market capitalization of each asset over the whole market is readily available in the
high frequency domain and low-frequency. For high frequency I have collected 5min price data from the
past five months on the popular exchange server Poloniex where investors are allowed to trade many

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cryptocurrencies for the US dollar. For low frequency, I have daily prices and market capitalization data
aggregated by exchanges servers for all cryptocurrencies since Bitcoin was created in 2008. Although I
have data for close to 1,400 cryptocurrencies, most of them are barely ever traded, so I will be looking
at roughly the 30 most popular ones.

References
[Christie and Huang, 1995] Christie, W. G. and Huang, R. D. (1995). Following the pied piper: do
individual returns herd around the market? Financial Analysts Journal, 51(4):31–37.
[Ciaian et al., 2018] Ciaian, P., Rajcaniova, M., and d’Artis Kancs (2018). Virtual relationships: Short-
and long-run evidence from bitcoin and altcoin markets. Journal of International Financial Markets,
Institutions & Money, 52:173–195.
[Hwang and Salmon, 2004] Hwang, S. and Salmon, M. (2004). Market stress and herding. Journal of
Empirical Finance, 11:585–616.
[Spyrou, 2013] Spyrou, S. (2013). Herding in financial markets: a review of the literature. Review of
Behavioral Finance, 5(2):175–194.