Volatility spillover between equity and cryptocurrency: an empirical study on the Colombo stock exchange

Abstract

Cryptocurrency markets have spillover effects on different financial markets. However, no studies have empirically investigated their spillover impact on the equity market of Sri Lanka. This study investigates the volatility transmission of spillover volatility between the Colombo Stock Exchange (CSE) and cryptocurrency markets considering the daily returns of the All Share Price Index (ASPI) and the Bitcoin (BTC). The analysis employs univariate Generalized Autoregressive Conditional Heteroskedasticity (GARCH) (1,1) models to capture volatility dynamics and a multivariate Dynamic Conditional Correlation (DCC)-GARCH model to examine the time-varying correlations between ASPI and BTC returns. The results reveal significant volatility clustering and high persistence in ASPI and BTC, with immediate shocks to volatility being more pronounced in BTC. Notably, past volatility has a more substantial impact on current volatility in ASPI compared to BTC. The DCC-GARCH model indicates a negligible negative correlation between ASPI and BTC returns, suggesting minimal spillover effects and potential diversification benefits. The understanding developed in this paper can help investors devise an appropriate strategy, policymakers design suitable regulations, and, lastly, guide market participants into designing innovative new financial products that will take care of the changing needs of the investors within the digital economy. Future research should investigate spillover effects in other emerging equity markets and consider additional factors such as regulatory changes and macroeconomic variables.