Modelling and Predicting the Conditional Variance of Bitcoin Daily Returns: Comparsion of Markov Switching GARCH and SV Models

ArXiv ID: 2401.03393 “View on arXiv”

Authors: Unknown

Abstract

This paper introduces a unique and valuable research design aimed at analyzing Bitcoin price volatility. To achieve this, a range of models from the Markov Switching-GARCH and Stochastic Autoregressive Volatility (SARV) model classes are considered and their out-of-sample forecasting performance is thoroughly examined. The paper provides insights into the rationale behind the recommendation for a two-stage estimation approach, emphasizing the separate estimation of coefficients in the mean and variance equations. The results presented in this paper indicate that Stochastic Volatility models, particularly SARV models, outperform MS-GARCH models in forecasting Bitcoin price volatility. Moreover, the study suggests that in certain situations, persistent simple GARCH models may even outperform Markov-Switching GARCH models in predicting the variance of Bitcoin log returns. These findings offer valuable guidance for risk management experts, highlighting the potential advantages of SARV models in managing and forecasting Bitcoin price volatility.

Keywords: Bitcoin, Volatility Forecasting, Stochastic Volatility, GARCH, Markov Switching, Cryptocurrency

Complexity vs Empirical Score

• Math Complexity: 7.5/10
• Empirical Rigor: 8.0/10
• Quadrant: Holy Grail
• Why: The paper employs advanced econometric models (MS-GARCH, SARV) with detailed parameter estimation and rigorous out-of-sample forecasting comparisons using multiple error metrics (MAE, MSE, QL), demonstrating both mathematical depth and empirical implementation.

  flowchart TD
    A["Research Goal: Model & Predict Bitcoin Volatility"] --> B["Methodology: MS-GARCH vs Stochastic Volatility"]
    B --> C["Data: Bitcoin Daily Log Returns"]
    C --> D{"Two-Stage Estimation"}
    D --> E["1. Estimate Mean Equation"]
    D --> F["2. Estimate Variance Equation"]
    E & F --> G["Forecast Evaluation: RMSE/MAE"]
    G --> H["Key Findings & Outcomes"]
    H --> I["SARV models perform best"]
    H --> J["Simple GARCH may outperform MS-GARCH"]