Connectedness of cryptocurrencies and prevailing uncertainties

Abstract

We investigate dynamic connectedness of cryptocurrencies using Generalized Forecast Error Variance Decomposition into short, medium, and long-term phases. Though all phases resemble similar drifts, the magnitude of short-term connectedness is much higher than medium and long-term. Notably, the U-shaped trajectory explains the increasing connectedness of cryptocurrencies with their heightened popularity in recent times. We further utilize Continuous Wavelet Transform to rationalize such connectedness with common economic and financial market uncertainty. Importantly, we show that as economic uncertainty increases, the connectedness among cryptocurrencies decreases. This highlights the potential for cryptocurrencies to be an alternative instrument for hedging against underlying uncertainty.