Predictors of Bitcoin Returns Revealed by Researchers

May 20, 2023

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• By Kevin Dollear, Illinois Institute of Technology

An empirical study by Illinois Institute of Technology researchers has identified blockchain technology, investor sentiment, and economic stress levels as significant predictors of bitcoin returns. The study sheds light on crucial empirical evidence that can guide investors, economists, and academics.

Sang Baum 'Solomon' Kang, Associate Professor of Finance at Stuart School of Business, Illinois Tech and co-author of the study, has concluded that the cryptocurrency is disengaged from economic fundamentals and may not effectively hold its ground as a safe-haven or diversifier asset. In addition, Kang has reported that bitcoin returns are not well predicted by returns on commodities, securities, or other assets.

The groundbreaking paper, 'What Information Variables Predict Bitcoin Returns? A Dimension-Reduction Approach,' published in The Journal of Alternative Investments, was co-written by Kang with his former doctoral students, Yao Xie and Jialin Zhao. The team employed dimension-reduction models and predictive analytics techniques to analyze 25 information variables under the categories of macroeconomics, blockchain technology, other assets, stress level, and investor sentiment, using data between January 2011 and January 2020.

Kang states, "We find that blockchain technology, investor sentiment, and stress level have predictive power for bitcoin returns. Similar to traditional assets, bitcoin shows higher return predictability with longer return horizons. These findings support the dual nature of bitcoin as a technical artifact and speculative asset."

The key findings of the study are:

• The researchers concluded that bitcoin has fulfilled three different economic roles over time - as a currency, as a speculative security, and as a safe-haven commodity due to its scarcity and mining costs.

Kang says, "In academia, there is a research methodology called the asset return predictability study. An underlying principle is that variables predicting the future movement of an asset price may be important in the economic system. So understanding what those variables are is important not only to traders who want to take a position in bitcoin, but also to economists who want to understand the nature of bitcoin."

More information: Sang Baum Kang et al, What Information Variables Predict Bitcoin Returns? A Dimension-Reduction Approach, The Journal of Alternative Investments (2023). DOI: 10.3905/jai.2023.1.187

Provided by Illinois Institute of Technology.