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

Previous research is inconclusive regarding the diversification benefit of cryptocurrency invest-ment. 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.