The Crypto Cycle and US Monetary Policy
IMF Working Papers, August 4, 2023
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- The Crypto Cycle and US Monetary Policy
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Bibliographic details
- Authors: Natasha X Che, Alexander Copestake, Davide Furceri, Tammaro Terracciano
- Published: August 4, 2023
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9798400245411.001
Key findings
- Identified a single price component—labeled the “crypto factor”—that explains 80% of variation in crypto prices.
- The increasing correlation of the crypto factor with equity markets coincided with the entry of institutional investors into crypto markets.
- US Fed tightening reduces the crypto factor through the risk-taking channel, mirroring effects on equities and contrasting claims that crypto assets provide a hedge against market risk.
- A stylized heterogeneous-agent model with time-varying aggregate risk aversion can explain the empirical findings and highlights possible spillovers from crypto to equity markets if institutional investor participation became large.
Empirical results and analysis
- Single latent component ("crypto factor") explains 80% of crypto price variation.
- Correlation pattern:
- The crypto factor’s rising correlation with equity markets temporally coincided with institutional investor entry into crypto markets.
- Monetary policy transmission:
- US Fed tightening reduces the crypto factor.
- The transmission operates via the risk-taking channel, similar to equities.
- Interpretation:
- Findings contrast claims that crypto assets hedge market risk.
- Evidence suggests increasing financial integration between crypto and traditional equity markets as institutional participation grows.
Model and theoretical contribution
- Model used:
- A stylized heterogeneous-agent model with time-varying aggregate risk aversion.
- Model implications:
- Reproduces empirical relationships between the crypto factor, equity markets, and US monetary policy.
- Highlights potential spillovers from crypto to equity markets under large institutional participation.
Policy implications and risks
- Monetary policy relevance:
- US monetary tightening affects crypto markets via the risk-taking channel, implying crypto markets are responsive to conventional macrofinancial policy tools.
- Financial stability considerations:
- Increased institutional participation raises the potential for spillovers between crypto and equity markets.
- Regulatory and monitoring priorities:
- Monitor institutional exposures and cross-market linkages to assess systemic risk transmission channels.
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- Working Paper