The Effect of COVID-19 and U.S. Monetary Policy on Bitcoin and Stock Market Volatility

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Introduction

Financial markets play a pivotal role in national economic development by bridging capital providers with those in need of investment. This mechanism allows companies to expand, hire, and innovate—driving broader prosperity. However, investors constantly face the risk of capital loss and asset depreciation. As such, risk mitigation and portfolio diversification remain central to sound investment strategy.

The global outbreak of the COVID-19 pandemic dramatically disrupted financial ecosystems, triggering sharp declines in stock markets and widespread economic uncertainty. In response, many investors shifted capital toward safer assets. Gold, long regarded as a traditional safe haven, saw increased demand due to its historical stability during crises. Simultaneously, Bitcoin (BTC) emerged as a compelling alternative. With a market capitalization exceeding $851 billion by late 2023—representing over half of the total crypto market—Bitcoin demonstrated strong performance during the pandemic, drawing interest from both retail and institutional investors.

Bitcoin's price surged notably, peaking in November 2021, while gold reached its high in March 2022. These divergent trends suggest differing hedging capabilities across market cycles. Moreover, both assets reacted to U.S. monetary policy normalization beginning in March 2022, when the Federal Reserve raised interest rates by 0.25%. This marked the start of a broader tightening cycle that led both Bitcoin and gold to decline, bottoming out in November 2022.

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This article investigates the dynamic relationship between Bitcoin, gold, and global stock market volatility during two critical periods: the COVID-19 crisis and the subsequent monetary policy normalization. Using the DCC-GARCH model, we analyze whether Bitcoin functions as a hedge or safe haven like gold—or if it behaves more as a speculative asset.

Core Keywords

These keywords reflect the central themes of this analysis and will be naturally integrated throughout the discussion.

Literature Review: Bitcoin, Gold, and Market Behavior During Crises

The pandemic reshaped investor sentiment globally. While stock markets plunged, Bitcoin and gold exhibited resilience, prompting renewed academic interest in their roles as risk mitigators.

Studies show that cryptocurrencies, particularly Bitcoin, react asymmetrically to market news—often increasing volatility in response to positive shocks, unlike traditional assets (Cheikh et al., 2020). This unique behavior suggests potential as both a speculative instrument and a diversification tool. Research by Platanakis and Urquhart (2019) found that adding Bitcoin to a traditional portfolio significantly enhances risk-adjusted returns.

However, findings are not uniform. Shahzad et al. (2020) concluded that gold offers more stable hedging benefits than Bitcoin for G7 stock markets. Conversely, Bouri et al. (2020) found Bitcoin outperformed gold in certain time-frequency bands, highlighting its value in dynamic portfolio strategies.

During the pandemic, Bitcoin showed increasing correlation with major stock indices—especially in advanced economies like the U.S., U.K., and Germany—indicating reduced hedging effectiveness when most needed. Yet, in emerging Asian markets such as Thailand and Vietnam, correlations remained weak, suggesting regional differences in Bitcoin’s safe haven potential.

U.S. monetary policy has also proven influential. Che et al. (2023) demonstrated that crypto prices react more strongly to Fed policy shifts than even global equities—declining by 0.15 standard deviations versus 0.1 for stocks. This challenges the notion that Bitcoin is decoupled from traditional finance.

Karau (2023) further noted that Bitcoin began responding to Federal Open Market Committee (FOMC) announcements only after late 2020, behaving increasingly like other risky assets such as equities and foreign exchange—but with greater sensitivity.

These insights underscore a key conclusion: Bitcoin’s role as a hedge is context-dependent, varying by region, market conditions, and macroeconomic policy.

Data and Methodology: Analyzing Dynamic Correlations

Data Overview

This study uses daily closing prices from January 4, 2017, to December 28, 2023—spanning three distinct phases:

  1. Pre-COVID-19: January 4, 2017 – January 29, 2020
  2. Pandemic Period: January 30, 2020 – March 16, 2022
  3. Monetary Policy Normalization: March 17, 2022 – December 28, 2023

Data includes major stock indices across ASEAN (Singapore, Malaysia, Indonesia), Asia (China, Japan, South Korea), Americas (U.S., Canada, Brazil), and Europe (UK, Germany, France). Bitcoin prices were sourced from CryptoDataDownload.com; stock data from Bloomberg.

Returns were calculated using logarithmic differences:

$$ r_t = \ln(P_t) - \ln(P_{t-1}) $$

Descriptive statistics reveal that mean daily returns were highest pre-pandemic and declined thereafter. Notably, several markets—including Singapore, Malaysia, and Canada—recorded negative returns during the rate-hiking phase.

Tests confirm data stationarity via Augmented Dickey-Fuller (ADF) and KPSS tests. ARCH effects were detected, justifying the use of GARCH modeling.

Why DCC-GARCH?

The Dynamic Conditional Correlation GARCH (DCC-GARCH) model is ideal for capturing time-varying relationships between financial assets. Unlike static models, DCC-GARCH allows correlations to evolve—critical during periods of crisis or policy shifts.

The model operates in two stages:

  1. Univariate GARCH estimation for each asset’s return series:

    $$ h_{i,t} = \omega_i + \alpha \mu_{i,t-1}^2 + \beta h_{i,t-1} $$

    Where $h_{i,t}$ is conditional variance, $\alpha$ captures short-term volatility persistence (ARCH effect), and $\beta$ reflects long-term persistence (GARCH effect).

  2. Dynamic correlation estimation:

    $$ R_t = Q_t^{*-1} Q_t Q_t^{*-1} $$

    With $Q_t$ updating based on past shocks and correlations—giving more weight to recent events.

This approach outperforms rolling-window methods by incorporating memory decay and improving forecast accuracy.

Key Findings: How Bitcoin Performed Across Market Phases

Pre-Pandemic: Independence Dominates

Before 2020, Bitcoin showed no significant correlation with any stock market index. Its returns were largely independent—supporting early claims of low integration with traditional finance.

During COVID-19: Correlations Emerge

As markets panicked in early 2020, significant dynamic correlations appeared between Bitcoin and indices in:

This implies that in some Asian markets, Bitcoin acted as a partial hedge—but in advanced economies, it moved more in tandem with equities.

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Post-March 2022: Monetary Tightening Reshapes Markets

After the Fed’s first rate hike on March 17, 2022:

For American and European markets, GARCH parameters remained significant—showing strong volatility persistence. However, Bitcoin’s inability to decouple from equity swings limited its hedging utility.

Gold vs. Bitcoin: A Comparative Analysis

Gold demonstrated clear safe haven properties pre-pandemic, with significant negative correlations to major indices (e.g., U.S., UK, Germany). When gold prices rose, stock returns fell—ideal for portfolio protection.

During the pandemic:

Still, overall robustness favored gold over Bitcoin—especially in crisis response and volatility dampening.

Frequently Asked Questions (FAQ)

Q: Is Bitcoin a safe haven like gold?

A: No—unlike gold, Bitcoin did not consistently act as a safe haven. While it showed some hedging potential in select Asian markets during the pandemic, it generally moved with equities in advanced economies, especially under monetary tightening.

Q: How does U.S. monetary policy affect Bitcoin?

A: Bitcoin is highly sensitive to Federal Reserve decisions. Rate hikes since March 2022 triggered sharp declines in crypto prices—more so than in traditional equities—indicating growing integration with conventional financial systems.

Q: Can Bitcoin improve portfolio diversification?

A: Yes—but conditionally. During stable or pre-crisis periods, Bitcoin offers diversification benefits due to low initial correlation. However, during systemic shocks or policy shifts, its correlation with stocks increases, reducing effectiveness.

Q: What is the DCC-GARCH model used for?

A: It measures how correlations between financial assets change over time. Unlike static models, it captures evolving relationships—essential for analyzing crisis periods or policy transitions.

Q: Why did gold outperform Bitcoin as a hedge?

A: Gold has a long-established reputation for stability during uncertainty. Empirical data shows it maintained stronger negative correlations with equities pre-pandemic and responded more predictably to macroeconomic shifts than Bitcoin.

Q: Should investors still consider Bitcoin during volatile markets?

A: Yes—but strategically. Bitcoin can enhance returns in growth phases but should not be relied upon solely for risk mitigation. Combining it with proven hedges like gold may yield better-balanced portfolios.

Conclusion: Rethinking Bitcoin’s Role in Modern Portfolios

The evidence suggests that Bitcoin’s function as a hedge is situational, not universal. It performed best as a diversifier in select emerging Asian markets during the pandemic but lost effectiveness in advanced economies under monetary tightening.

In contrast, gold maintained consistent safe haven characteristics, especially before and after major shocks. Its behavior aligns more closely with traditional expectations of a crisis-resistant asset.

For investors:

For policymakers:

Ultimately, while Bitcoin has matured as an asset class, it has not replaced gold as a reliable hedge. Its true value lies in offering alternative return streams—not unconditional safety.

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