SPILLOVER AND CONNECTEDNESS BETWEEN DECENTRALIZED FINANCE (DEFI) TOKENS AND MAJOR FINANCIAL BENCHMARKS: A VAR- BASED ANALYSIS THESIS

Abstract

This study investigates the return spillovers and connectedness between decentralized finance (DeFi) tokens—AAVE, LINK, MKR, and SNX—and major financial benchmarks including the S&P 500, Nikkei 225, Euro Stoxx 50, Gold, U.S. Dollar Index (DXY), and 3-Month Treasury Bills. Using a VAR-based Diebold-Yilmaz framework, this research examines the magnitude and direction of return transmission across these assets from January 2021 to December 2024. The methodology includes descriptive statistics, unit root testing, lag selection, VAR model estimation, and generalized forecast error variance decomposition (GFEVD) to quantify directional and net spillovers. Additionally, time-varying connectedness is analyzed using rolling windows of 100 days. The results reveal significant interdependence, with total spillover indices averaging 48.7% over the sample period, indicating that nearly half of the forecast error variance in returns is explained by spillovers across assets. Directional spillovers from DeFi tokens to benchmarks average 12.3%, while spillovers from benchmarks to DeFi tokens average 15.6%, highlighting a bidirectional transmission. Net spillover effects show AAVE and LINK as net transmitters (net spillovers of 3.2% and 2.8%, respectively), whereas S&P 500 and Gold are net receivers (net spillovers of -4.1% and -3.5%, respectively). Time-varying analysis indicates heightened connectedness, with the spillover index peaking at 67.1% during the Terra-LUNA collapse in May 2022 and 62.4% during the FTX bankruptcy in November 2022, reflecting DeFi's growing systemic relevance during market stress. This study contributes to the understanding of financial contagion and portfolio diversification in the digital asset era. It also offers insights for policymakers and investors regarding the integration of DeFi tokens into broader financial ecosystems.