Essays on Financial Innovations: Expected Returns and Volatility in the Cryptocurrency Market

This dissertation consists of five essays that examine expected returns and volatility in the cryptocurrency market. The first essay analyses the profitability of momentum trading strategies in digital currencies. The results show that a plain momentum strategy does not yield significant returns due to crashes in individual cryptocurrencies, but that risk management through volatility-scaling methods generates substantial gains, both with and without factor model risk adjustment. The second essay explores how the momentum anomaly manifests when focusing on cryptocurrencies with high liquidity and stability over time. The findings indicate that momentum is not driven by digital currencies with smooth return processes, but rather by those that temporarily reach high liquidity levels. The third essay investigates the transition from the Proof-of-Work (PoW) to the Proof-of-Stake (PoS) consensus protocol and its impact on the relationship between cryptocurrency volatility and energy shocks. The results reveal a marked decline in the sensitivity of digital currencies to energy market shocks after the adoption of PoS, supporting the shift towards a more environmentally sustainable protocol. The fourth essay models cryptocurrency volatility using power law distributions. The analysis shows that altcoins share a common risk process that follows power law behaviour, suggesting that the scope for risk diversification is limited. The fifth essay examines the market reaction to the new Basel framework regulating banks’ exposures to cryptoasset volatility. The event study results indicate a negative market reaction, suggesting that regulators’ stance may be overly stringent and that the framework may warrant revision. Taken together, this dissertation contributes to the literature by assessing the profitability of traditional trading strategies in cryptocurrency markets, highlighting sources of uncertainty, and identifying potential tools for risk management.