Assessing time-and-frequency-domain cross-market volatility contagion: a comparative study of decentralized finance assets and global traditional financial markets

Abstract

Purpose The evolution of financial technology has been rapid, culminating in the mainstream acceptance and adoption of blockchain technology over the past decade. By providing the foundational infrastructure on which smart contracts and decentralized applications can be built and operated, the Ethereum blockchain facilitated the emergence of decentralized finance (DeFi). Not only have DeFi instruments increased portfolio options for investors, but they also have the potential to influence volatility transmissions both in traditional financial markets and within the digital space. To better inform policymaking, risk management and portfolio construction, this study aims to investigate both the time-based and frequency-based volatility connectedness among four leading DeFi instruments and 12 traditional financial markets. Design/methodology/approach This study analyzes weekly price data ranging from October 05, 2020, to March 04, 2024. The study employs advanced econometric frameworks (Diebold–Yilmaz and Baruník–Krehlík models) to estimate both the time-based and frequency-domain volatility connectedness among the studied financial instruments. Findings Empirical results show that the DeFi instruments are highly interconnected, the very-large financial markets are highly interconnected and there are low connections between DeFi instruments and traditional financial markets. Moreover, the larger (smaller) stock markets are net volatility transmitters (receivers). Overall, the volatility connectedness among all the studied instruments is moderate (48.4% on average), with the instruments being most (least) connected in the long (short) term. Originality/value This study expands the literature by including major DeFi assets that have been largely overlooked. Also, the study introduces novelty by incorporating global markets. In fact, to the best of the authors’ knowledge, it is the first study to analyze both time- and frequency-based volatility connectedness among DeFi assets and global financial markets.