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

Abstract

This study addresses a gap in the literature by exploring the impact of geopolitical risk on cryptocurrency markets, particularly Bitcoin, within different price and volatility regimes. We employed generalized autoregressive conditional heteroskedasticity (GARCH) and Markov-Switching Vector Autoregressive (MS-VAR) models on daily data from January 01, 2015 to January 15, 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 were associated with decreased current Bitcoin volatility, particularly in state 1 characterized by lower price levels. Conversely, in state 2, which is characterized by higher price levels, geopolitical risk shocks initially spike, followed by a subsequent decrease in Bitcoin price volatility. Furthermore, shock analysis revealed nuanced reactions of Bitcoin prices and volatility to geopolitical events, with distinct patterns observed for different price regimes. Geopolitical risk can explain the variance in Bitcoin prices and volatility in lower-price-level states. These results suggest that adopting dynamic investment approaches that adjust to changing geopolitical conditions and market regimes can help investors navigate cryptocurrency market fluctuations more effectively.