Macroeconomic fundamentals and cryptocurrency prices: A common trend approach

• Published date: 01 March 2023
• Author: Xiaoquan Jiang,Iván M. Rodríguez,Qianying Zhang
• Date: 01 March 2023
• DOI: http://doi.org/10.1111/fima.12412

DOI: 10.1111/fima.12412

ORIGINAL ARTICLE

Macroeconomic fundamentals and cryptocurrency

prices: A common trend approach

Xiaoquan Jiang1Iván M. Rodríguez Jr.2QianyingZhang3

1Department of Finance, College of Business,

Florida International University, Miami,

Florida, USA

2Department of Accounting, Finance, &

Information Systems, College of Business,

Eastern Michigan University, Ypsilanti,

Michigan, USA

3Department of Economics, Business, and

Accounting, Hillsdale College, Hillsdale,

Michigan, USA

Correspondence

Xiaoquan Jiang, Department of Finance,

College of Business, Florida International

University,11200 SW 8th Street, Miami, FL

33199, USA.

Email: jiangx@fiu.edu

Weare grateful to Andrew Karolyi

(discussant),Gustavo Grullon (discussant),

Andrew Lynch(discussant), editor Bing Han, an

anonymousreferee, andseminar participants

at the 2020 Diversity Emerging Scholars

Initiative (DESI) at the FinancialManagement

Association Annual Conference, 2021 China

International Risk Forum,and 2022 Southern

Finance Association Annual Conference for

their helpful comments. All remaining errors

are our own. The authors do not haveany

conflicts of interest, as identified in the

Disclosure Policy.

Abstract

Basedonassetpricingtheory,wepositandfindthat

equity marketsand cryptocurrency markets share a common

fundamental. Our cointegration tests show that the most

important asset pricing primitive, consumption, can serve

as the common fundamental. We further show that addi-

tional macroeconomic factors, as well as uncertainty and

sentiment, all play a role in explainingthe deviation from fun-

damentals. To understand the linkage between equity mar-

kets, cryptocurrency markets, and the macroeconomy, we

suggest the following three channels: (i) portfolio allocation

decisions, (ii) intermarket order flows, and (iii) technological

adaption expectations.

KEYWORDS

Bitcoin, cointegration, equity, fintech

JEL CLASSIFICATION

G10, G12, G18

1INTRODUCTION

The novelty and volatility of cryptocurrency prices have led policymakers and investorsto adopt the belief that its

price dynamics are determined purely by speculative behavior from irrational agents.1This has spurred the fintech

© 2022 Financial Management Association International.

1Forexample, Jamie Dimon (CEO of JP Morgan) describes Bitcoin as a “fraud” and the traders investingin Bitcoin as “stupid” (Jamie Dimon Slams Bitcoin asa

‘Fraud’,2017),whereas former Federal Reserve Chairman Alan Greenspan states “You have to really stretch yourimagination to inferwhatthe intrinsic value

Financial Management. 2023;52:181–198. wileyonlinelibrary.com/journal/fima 181

182 JIANG ET AL.

literature’s efforts in trying to document stylized facts and theoretically understand the mechanisms that drive these

empirical regularities. One of the key facts that have seemingly been uncovered is the lack of connection between

equity markets and cryptocurrency markets.However, this is puzzling from an asset pricing perspective that predicts

commonality between different markets.

We resolve this puzzle by using cointegration tests to show that cryptocurrency prices are indeed determined by

economic fundamentals and investigatethe role that the macroeconomy may have in driving the price process of cryp-

tocurrencies. In contrast to conventional wisdom, our results show that cryptocurrency prices and equity prices are

cointegrated and determined by common fundamentals. We find that cryptocurrency price contains a more transi-

tory component reflecting the high volatility of cryptocurrencies compared to equity prices. The deviation from these

fundamentals is not only due to speculative sentiment but also macroeconomic factors and time-varying uncertainty.

These results rule out models where cryptocurrency prices are solely driven by “irrationalexuberance.”

Our study is the first, to our knowledge, in taking this approach to establish the long-run equilibrium relation

between prices of equities, cryptocurrencies, and macroeconomic fundamentals, and examine whether macroeco-

nomic fundamentals explain the fluctuations of the cryptocurrency market. Our methods and results complement

Bhambhwani et al. (2019), who examinecointegration from a microperspective. We empirically investigate whether a

long-run equilibrium exists between equity and cryptocurrency prices and if macroeconomic fundamentals drive the

long-run equilibrium by taking a theoretically grounded empirical approach.

The theoretical motivation for a common long-run fundamental is relatively straightforward. The present value

model implies that price is cointegrated with its fundamentals if the fundamental growth rate is stationary

(see, e.g., Campbell & Shiller, 1987; Engel & West, 2005). However, the lack of consensus on cryptocurrency funda-

mentals makesi tdifficult toempirically identify.We circumvent this impediment by exploiting a nascent development

in the asset pricing literature, showing that return variation across asset classes can be explained by a common risk

factor (e.g., Cochrane, 2011; Koijen et al., 2018; Lettau et al., 2014). Our study is also motivated bya key insight from

Bossaerts (1988). In economies where two-fund separation holds in an approximate sense, Bossaerts (1988)argues

that asset prices are cointegrated due to nonstationary common state variables.2

To address whether macroeconomic factors play a role in equilibrium, we take a twofold approach. In our first

approach, from the perspective of consumption-based asset pricing models, we consider an economy in which aggre-

gate wealth consists of two asset classes: equities and cryptocurrencies. Motivated by Campbell and Mankiw (1989)

andLettau and Ludvigson (2001a), we focus on the representative agent’s budget constraint and derive a cointegration

relation between aggregate consumption, equities, and cryptocurrencies. This allows us to directly test for a common

fundamentalamong these three variables. Our results strongly support the existence of a long-run equilibrium relation

and indicate that consumption is able to serve as a common fundamental between equity and cryptocurrency prices.

Our results are also consistent with the international finance literature that links currency returns to consumption

growth (e.g., Burnside, 2012; Lustig et al., 2011).

In our second approach, we investigate the determinants of deviations from the long-run equilibrium because the

deviation predicts expected future cryptocurrency returns. Explaining the source of equilibrium deviations will help

us understand the economic contents of cryptocurrency price fluctuations. We use asset pricing theory to help guide

the set of candidate state variables: the consumption-wealth ratio, GDP growth, unemployment rate, uncertainty,

and investor sentiment. Our empirical results show that macroeconomic fundamentals, uncertainty, and investor

sentiment are important factors that influence cryptocurrency prices.

To further understand the long-run equilibrium relationship, we explore three plausiblemechanisms linking the

equity market, cryptocurrency market, and the macroeconomy.First, the state of the economy jointly affects wealth,

consumption, and investment decisions. Therefore, if investors hold cryptocurrency in their portfolios, their allo-

cation decisions will jointly affect cryptocurrency and equity prices through demand changes driven by economic

ofBitcoin is. I haven’t been able to do it. Maybe somebody else can” (Greenspan Says Bitcoin a Bubble Without Intrinsic Currency Value,2013). The IMF notes

thatcryptocurrencies, unlike other financial assets, “[have] their value depends entirely on self-fulfilling expectations” (IMF,2019, p. 25).

2Ineconomies where two-fund separation holds strictly (e.g., CAPM), asset prices will be collinear with the state variables.