A Horserace of Volatility Models for Cryptocurrency: Evidence from Bitcoin Spot and Option Markets

TL;DR

This paper compares various volatility models for Bitcoin, finding GARCH and EGARCH outperform others, and demonstrates a profitable trading strategy based on volatility spreads and delta-hedging.

Contribution

It provides a comprehensive comparison of volatility models for Bitcoin and introduces a profitable trading strategy exploiting volatility spreads.

Findings

GARCH and EGARCH models outperform others in Bitcoin volatility forecasting

The EGARCH model's asymmetric term is insignificant, indicating symmetric volatility response

A simple volatility-spread trading strategy yields robust profits

Abstract

We test various volatility models using the Bitcoin spot price series. Our models include HIST, EMA ARCH, GARCH, and EGARCH, models. Both of our in-sample-fit and out-of-sample-forecast results suggest that GARCH and EGARCH models perform much better than other models. Moreover, the EGARCH model's asymmetric term is positive and insignificant, which suggests that Bitcoin prices lack the asymmetric volatility response to past returns. Finally, we formulate an option trading strategy by exploiting the volatility spread between the GARCH volatility forecast and the option's implied volatility. We show that a simple volatility-spread trading strategy with delta-hedging can yield robust profits.