Sentiment and Feedback Trading in Bitcoin Markets

Ivan Estevez de la Cruz & Imke Marie Prang

Student thesis: Master thesis


With the increasing research on behavioural economics in recent years, the topics of feedback trading and sentiment have received considerable attention. Previous research on feedback trading proposed various models for the behaviour of investors in financial markets. The relationship between volatility and feedback trading, usually recognized through serial correlation of stock returns, has been well investigated. Given the growing exposition of Bitcoin to financial activity and the considerable fluctuation of its prices, it represents a key opportunity to study investor sentiment and feedback trading and their relationship to volatility. Research on feedback trading is scarce as Bitcoin markets are still evolving and subject to changing dynamics. Our ambition is to advance the understanding of investor behaviour in Bitcoin markets with respect to feedback trading and investor sentiment. We investigate the serial correlation of returns and examine its relationship with conditional volatility and sentiment. We apply Sentana and Wadhwani’s (1992) feedback trading model and the extensions proposed by Chau et al. (2011) that allow for sentiment. To proxy for investor sentiment, we calculate the Baker and Wurgler (2006) investor sentiment index. We find that with increasing volatility, the prominence of positive feedback trading also increases in Bitcoin markets which is consistent with Sentana and Wadhwani’s (1992) findings in stock markets. In contrast, for low levels of volatility, the presence of positive feedback trading is smaller and Bitcoin returns are positively correlated. Our main findings are this inverse relationship between serial correlation of returns and volatility, as well as a predominance of positive autocorrelation in returns. When analysing the impact of U.S. investors’ sentiment in feedback trading in Bitcoin markets, our results are ambiguous and inconclusive. The reason for this is rooted in the difficulty in replicating the index constructed by Baker and Wurgler (2006) and the intrinsic difficulty of measuring investor sentiment in Bitcoin markets. Nonetheless, the results obtained in our analysis further the understanding of positive feedback trading, volatility, and sentiment in Bitcoin markets.

EducationsMSc in Finance and Strategic Management, (Graduate Programme) Final Thesis
Publication date2019
Number of pages109