The evolution of financial technology has been rapid, culminating in the mainstream acceptance and adoption of blockchain technology over the past decade. By providing the foundational infrastructure on which smart contracts and decentralized applications can be built and operated, the Ethereum blockchain facilitated the emergence of decentralized finance (DeFi). Not only have DeFi instruments increased portfolio options for investors, but they also have the potential to influence volatility transmissions both in traditional financial markets and within the digital space. To better inform policymaking, risk management and portfolio construction, this study aims to investigate both the time-based and frequency-based volatility connectedness among four leading DeFi instruments and 12 traditional financial markets.
The image presents a diagram comparing cross-market volatility contagion between Decentralized Finance (DeFi) assets and traditional markets. The top section features the title and key metrics indicating average connectedness, high intra-market connectedness, and low cross-market spillovers. The left circle labeled "DeFi Assets" illustrates high internal connectedness, featuring four interconnected blue circles, suggesting strong internal relationships. The right circle titled "Traditional Markets" shows size-based connectedness with four colored circles indicating varying levels of connectedness. Below both sections, three categories, short term, medium term, and long term, are highlighted in distinct colors with descriptions indicating their respective levels of connectedness. The arrangement flows left to right, with each component aligned horizontally within its section.The image presents a diagram comparing cross-market volatility contagion between Decentralized Finance (DeFi) assets and traditional markets. The top section features the title and key metrics indicating average connectedness, high intra-market connectedness, and low cross-market spillovers. The left circle labeled "DeFi Assets" illustrates high internal connectedness, featuring four interconnected blue circles, suggesting strong internal relationships. The right circle titled "Traditional Markets" shows size-based connectedness with four colored circles indicating varying levels of connectedness. Below both sections, three categories, short term, medium term, and long term, are highlighted in distinct colors with descriptions indicating their respective levels of connectedness. The arrangement flows left to right, with each component aligned horizontally within its section.This study analyzes weekly price data ranging from October 05, 2020, to March 04, 2024. The study employs advanced econometric frameworks (Diebold–Yilmaz and Baruník–Krehlík models) to estimate both the time-based and frequency-domain volatility connectedness among the studied financial instruments.
Empirical results show that the DeFi instruments are highly interconnected, the very-large financial markets are highly interconnected and there are low connections between DeFi instruments and traditional financial markets. Moreover, the larger (smaller) stock markets are net volatility transmitters (receivers). Overall, the volatility connectedness among all the studied instruments is moderate (48.4% on average), with the instruments being most (least) connected in the long (short) term.
This study expands the literature by including major DeFi assets that have been largely overlooked. Also, the study introduces novelty by incorporating global markets. In fact, to the best of the authors’ knowledge, it is the first study to analyze both time- and frequency-based volatility connectedness among DeFi assets and global financial markets.
