Measuring Market Volatility

Measuring Market Volatility

Nahid Ibrahimzade

Nahid Ibrahimzade

MELD Ambassador

August 11, 2022

It is a known fact that the crypto market is quite volatile. An enormous increase in the price of coins or tokens can be followed by a sharp decrease, causing the investors to gain or lose depending on their position. However, unless put in numbers, it is hard to measure the volatility. In this article, I will touch upon the volatility index (VIX), the beta factor within the CAPM model, and compare other cryptocurrencies to Bitcoin.

What is the Volatility Index?

Developed by the CBOE, (VIX) represents the market’s expectations for the relative strength of near-term price changes of the S&P 500 Index (SPX). It is calculated based on index options with near-term expiration dates and generates a 30-day forward projection of volatility.

Deribit introduced the Deribit Implied Volatility Index (DVOL) and showed how it can be calculated. The higher the VIX, the greater the level of fear and uncertainty in the market, with levels above 30 indicating tremendous uncertainty. On 20 March 2020, due to the uncertainty that Covid brought to markets, VIX hit 66.04. On 13 June 2022, VIX index hit 34.02, once again proving the uncertainty in the stock markets amid recent interest rate hikes, increased inflation, and ongoing war.

The DVOL hit 108.67 on 18 Jun 2022, showing how volatile the crypto market is, in comparison to the stock market. 

What is a Beta Factor?

The beta factor, used in the Capital Asset Pricing Model (CAPM) model, indicates how one asset performs over the same period compared to the market. Investors who prefer having less risky portfolios might prefer having stocks with a beta of between 0 and 1. A detailed explanation can be found here. Below is how the CAPM model is calculated:

But the ones who prefer more risky assets can have higher beta stocks. For example, a beta of 1.5 would mean that if the market moves up or down by 1%, then this stock would move up or down 1.5% plus a risk-free rate return. When we say the market here, usually the SP500 index is considered. For example, Apple has a beta of 1.20 at the moment per yahoo finance and a calculation that I did before writing this article. 

What can be Considered ‘The Market’ in Crypto? 

The lack of the crypto index causes trouble here. Because if there would be an index of top 100 coins or even top 500 coins (similar to SP500), then this could be used as a market indicator. However, creating and calculating an index for a crypto market is not covered in this article. For simplicity, BTC-USD pair returns were taken as a market index. Usually, it is a standard that the past 5-years’ monthly returns are taken into the beta calculation. However, considering the price swings of the crypto market and many coins were created only in the last 2-3 years, weekly returns from the beginning of 2020 were chosen. Additionally, not only weekly returns but also daily returns will be taken into the calculation, and the results are shown below. 

Firstly, for weekly returns considering BTC-USD as ‘the market’, we look at the beta factor of Cardano, Ethereum, Binance Coin, Avalanche, Ripple, and Solana:

Except ETH, having other coins’ beta factors less than 1 is counter-intuitive, and I was expecting a much higher number. It means that during this period, compared to Bitcoin, other coins increased less or decreased less. However, by looking at the price development of other coins during the last 2 years, actually, vice-versa is true. If Bitcoin price increased, others increased even more, and if Bitcoin decreased, others decreased even more. However, this can be due to the limitation of using weekly returns. 

Hence, I conduct the same analysis of the calculation of beta factors for daily returns of Cardano, Ethereum, Binance Coin, Avalanche, Ripple, and Solana:

By taking daily returns data, the above beta factors reflect a much closer look to reality. The lowest is AVAX, with a beta factor of 9.16. While Bitcoin is considered a volatile asset, it shows how other coins are volatile compared to Bitcoin. Additionally, the higher beta factors also indicate that if Bitcoin’s price were to rise, others would be increasing at a much higher rate. And also vice versa, as we experience currently, other coins are losing much more in terms of spot price in a bear market.

Conclusion

In this article, the basic idea of volatility was introduced, and the volatility index was mentioned. The Capital Asset Pricing Model (CAPM) model was shortly introduced, and a beta calculation of coins using bitcoin as a market index was performed. Not having a crypto index is a major limitation, and will be attempted in a future article. By using weekly returns data, the beta calculation did not yield the desired result. Unlike conventional market calculation, using daily returns for the crypto market may be a better reflection of the market dynamics in the form of the  beta factor.

Disclaimer

The opinions shared within this article are those solely of the MELD Ambassador. Note that the content within should not be considered financial, legal, or tax advice. Neither the author nor MELD Labs PTE Ltd. are financial, legal or tax advisors. None of this content should be used to make any form of financial, tax, or legal decisions. Do your own research and consult professionals as needed for official policies, restrictions, and requirements in your jurisdiction.

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Tags
Economics & Tokenomics

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