Li, Leon2023-03-052023-03-052023-02-70003-6846https://hdl.handle.net/10289/15597Previous research has shown volatility jumps and co-jumping behaviours in cryptocurrency markets. Motivated by these findings, we employ the herding effect and financial contagion channel to outline a theoretical framework of volatility-state-dependent correlations in cryptocurrency markets. We show that digital currency markets are more strongly correlated when experiencing an identical volatility regime, which echoes co-jumping behaviours addressed by the literature. Moreover, the strong correlation that occurs when the paired cryptocurrencies simultaneously experience a high volatility regime results in the least effectiveness of diversification in terms of a minimum portfolio risk reduction. Last but not least, the proposed state-dependent approach in this study proves effective at the task of risk forecasting and risk reduction for cryptocurrency portfolios, beyond the bivariate GARCH-based models, which are a pure and simple time-dependent approach.application/pdfen© 2023 The Author(s). This is an Open Access article distributed under the terms of the Creative Commons Attribution-NonCommercial-NoDerivatives License.Journal Article10.1080/00036846.2023.21709701466-4283