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Emergence of Non-Speculative Demand for Bitcoin: Learning about Stochastic Correlations with Stock Markets

When a new asset keeps changing its narrative, investors find difficulty in classifying and understanding the new asset. Rational investors therefore face unprecedented uncertainty and learn about the joint dynamics to optimize their portfolio accordingly. Bitcoin's "digital gold" narrative, as a safe haven, best demonstrates this uncertainty-learning behavior. We find that an increase in investors' estimates on the correlations between Bitcoin and the US stock markets strongly predict lower subsequent Bitcoin returns, consistent with a mean-variance framework. However, portfolio optimization errors associated with uncertainty in volatilities are 30 times greater than those with correlations; therefore, volatility-related predictors fail to explain Bitcoin returns. The same empirical patterns appear in out-of-sample predictions, global equity markets, and other cryptocurrencies.