Risk Premia in the Bitcoin Market

We analyze the first and second moment risk premia in the Bitcoin market based on options and realized returns and contrast them to the premia embedded in the main US stock index market. First, Bitcoin is much more volatile and has a higher variance risk premium than the S&P 500. By decomposing the return premium into different regions of the return state space, we find that while most of the S&P 500 equity premium comes from mildly negative returns, the corresponding negative Bitcoin returns (between three and one standard deviations) account for only one-third of the total Bitcoin premium (BP). Further, applying a novel clustering algorithm to a collection of estimated Bitcoin option-implied risk-neutral densities, we find that risk premia vary over time as a function of two distinct market volatility regimes. The low-volatility regime implies a relatively high share of BP attributable to positive returns and a high Bitcoin Variance Risk Premium (BVRP). In high-volatility states, the BP attributable to positive and negative returns is more balanced, and the BVRP is lower. These results suggest Bitcoin investors are more concerned about variance and upside risk in a low-volatility regime.