ANALYSING THE CORRELATION BETWEEN COLOMBO STOCK EXCHANGE RETURNS AND CRYPTOCURRENCY RETURNS

Abstract

"This research examines the dynamic relationship between returns from the Colombo Stock Exchange (CSE) and cryptocurrency, utilising proxies such as BTC/USD daily returns and the All-Share Price Index (ASPI) daily returns. The primary objective of this study is to investigate whether cryptocurrencies offer diversification potential for Sri Lankan investors. Therefore, this research fills a critical empirical gap by being the first to apply the Dynamic Conditional Correlation Generalised Autoregressive Conditional Heteroskedasticity (DCC- GARCH) model to the Sri Lankan context. The study employs the DCC-GARCH model to analyse time-varying correlations using daily data from 2015 to 2023. A quantitative approach was used with secondary data obtained from Investing.com and analysed in EViews 8. The study shows a weak correlation between ASPI returns and BTC/USD returns, typically around zero, indicating their structural independence. However, during economic shocks like the COVID-19 pandemic, correlations spiked, reflecting investor behaviour, but reverted to near-zero levels post-pandemic. On average, the correlation coefficient remained close to zero, confirming minimal co- movement. Although both markets show persistent volatility, the study concludes that Sri Lankan investors can only profit from limited diversification due to their weak link. Regulatory restrictions and restricted exposure to cryptocurrencies further underscore this. These findings provide practical implications for portfolio diversification and regulatory oversight. The study contributes to the limited regional literature by empirically quantifying the dynamic link between stock and crypto markets in Sri Lanka.