Correlation without Factors in Retail Cryptocurrency Markets

ArXiv ID: 2412.04263 “View on arXiv”

Authors: Unknown

Abstract

A simple model-free and distribution-free statistic, the functional relationship between the number of “effective” degrees of freedom and portfolio size, or N*(N), is used to discriminate between two alternative models for the correlation of daily cryptocurrency returns within a retail universe of defined by the list of tradable assets available to account holders at the Robinhood brokerage. The average pairwise correlation between daily cryptocurrency returns is found to be high (of order 60%) and the data collected supports description of the cross-section of returns by a simple isotropic correlation model distinct from a decomposition into a linear factor model with additive noise with high confidence. This description appears to be relatively stable through time.

Keywords: Degrees of Freedom, Isotropic Correlation Model, Linear Factor Model, Pairwise Correlation, Distribution-free Statistic, Cryptocurrencies

Complexity vs Empirical Score

  • Math Complexity: 6.5/10
  • Empirical Rigor: 4.0/10
  • Quadrant: Lab Rats
  • Why: The paper introduces an advanced statistical method (effective degrees of freedom N*) with significant mathematical derivations for comparing isotropic vs. factor models, but the empirical analysis is limited to a single small dataset (14 cryptos) with no reported backtests or out-of-sample validation, placing it in the theoretical-research domain.
  flowchart TD
    A["Research Goal:<br>Test Linear Factor Model vs.<br>Isotropic Correlation in Crypto"] --> B["Input Data:<br>Daily Crypto Returns (Robinhood)"]
    B --> C["Methodology:<br>Model-Free Distribution-Free<br>Statistic (DF vs N)"]
    C --> D["Compute:<br>Avg Pairwise Correlation"]
    C --> E["Compute:<br>Effective Degrees of Freedom N*(N)"]
    D & E --> F["Comparison:<br>Empirical DF vs. Model Predictions"]
    F --> G["Outcome:<br>Data supports Isotropic Model<br>Avg Correlation ~60%<br>Reject Linear Factor Model"]
    G --> H["Time Analysis:<br>Findings Stable Across Time"]