Bitcoin Connectedness and Portfolio Diversification across Economies with High Cryptocurrency Adoption

Abstract

This paper examines the return connectedness between Bitcoin and stock indices of economies with high levels of cryptocurrency adoption. Such economies are predominantly emerging markets characterized by elevated inflation, poor institutional quality, and macroeconomic and political instability, creating conditions under which investors may reallocate from traditional assets to Bitcoin during episodes of increased uncertainty. To assess this linkage, we employ a TVP-VAR framework with frequency-domain decomposition. Our results indicate only modest return connectedness under normal market conditions, which intensifies during periods of market turmoil. This observed pattern, along with low correlation and the identification of Bitcoin as a net return receiver, led to testing the portfolio diversification potential of Bitcoin. The evidence indicates that Bitcoin contributes to both risk mitigation and return enhancement at low hedging costs. The effect is more pronounced for emerging-market portfolios than for developed markets.