Modelling and forecasting the volatility of bitcoin futures: the role of distributional assumption in GARCH models

Abstract

<abstract><p>The Bitcoin futures market is growing and, as such, becoming more sophisticated. A small change in price may therefore have a large impact on the market. This paper investigates the propensity of 18 different competing GARCH family models and error distributions to model and forecast the volatility of Bitcoin futures returns. The study employs two different time periods (from January 2, 2018 to June 14, 2021; and March 11, 2020 to June 14, 2021). From the results, iGARCH(1, 1)-Students't-distribution (STD) is selected as the best performing model among the constructed models for the first period. By fitting the best three models from the first period to the second period, the iGARCH(1, 1)-STD is again selected as the optimal model. However, the iGARCH(1, 1)-normal inverse Gaussian (NIG) provides a significant variance forecast when used for in-sample and out-of-sample forecasts before the financial crisis and during the financial crisis, respectively. Our results indicate the impacts of past squared shocks on squared returns of Bitcoin futures and the ability of iGARCH(1, 1)-STD to capture such innovations and the propensity of iGARCH(1, 1)-NIG to optimally forecast the variance of Bitcoin futures returns.</p></abstract>