Navigating Global Uncertainty: Examining the Effect of Geopolitical Risks on Cryptocurrency Price and Volatility in Markov-Switching Vector Autoregressive Model

Abstract

Abstract This study addresses a gap in the literature on exploring the impact of geopolitical risk on cryptocurrency markets, particularly focusing on Bitcoin, within different price and volatility regimes. By employing generalized autoregressive conditional heteroskedasticity (GARCH) and Markov-Switching Vector Autoregressive (MS-VAR) models using daily data from 01 January 2015 to 15 January 2024. We found evidence suggesting a strong positive relationship between lagged Bitcoin returns and current returns, indicating persistence or momentum in Bitcoin price movements. Additionally, heightened geopolitical risks are found to be associated with decreased current Bitcoin volatility, particularly in state 1 characterized by lower price levels. Conversely, in state 2, characterized by higher price levels, geopolitical risk shocks induce an initial spike followed by a subsequent decrease in Bitcoin price volatility. Furthermore, shock analysis reveals nuanced reactions of Bitcoin prices and volatility to geopolitical events, with distinct patterns observed in different price regimes. Geopolitical risk is found to explain the variance of Bitcoin price and volatility in lower price level states. Given these results, it is recommended that adopting dynamic investment approaches that adjust to changing geopolitical conditions and market regimes can help investors navigate fluctuations in cryptocurrency markets more effectively. JEL Classifications: G10, G14, F42