Can Bitcoin, and other cryptocurrencies, be modeled effectively with a Markov-Switching approach?
Abstract: This research is an attempt at deepening the understanding of hyped cryptocurrencies. A deductive nature is used where we attempt to estimate the linear dependencies of cryptocurrencies with four different time series models. Investigating linear dependencies of univariate time series offers the reader an understanding on how previous prices of cryptocurrencies affect future prices. The linear interdepencies for a multivariate scenario will provide an apprehension on how, and if, the cryptocurrency market is correlated. The dataset used consists of the prices between January 1, 2016 to March 31, 2019 of the four cryptocurrency rivals: Bitcoin, Ethereum, Ripple and Litecoin. The modeling is performed by using autoregression and fitting on 80% of the data. Thereafter, the models are forecasted on the last 20% of the data in order to test the accuracy of the model. The four types of model are used in this thesis and are named by the abbreviations AR(p), MSAR(p), VAR(p) and MSVAR(p) where AR(p) represents an autoregressive model of order p; MSAR(p) represents a Markov-Switching autoregressive model of order p; VAR(p) represents a multivariate model for of the AR(p) also known as the vector autoregressive model of order p; finally MSVAR(p) stands for a Markov-Switching vector autoregressive model of order p. As cryptocurrencies are said to be very volatile, we hope that the Markov-Switching approach would help to classify the level of volatility into different regimes. Further, we anticipate that the fitted time series for each regime will offer a greater accuracy than the regular AR(p) and VAR(p) models. By using scale-dependent error estimators, the thesis concludes that the Markov-Switching approach does in fact improve the efficiency of chosen time series models for our cryptocurrencies.
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