Investing with Cryptocurrencies – evaluating their potential for portfolio allocation strategies

Quantitative Finance (2021): 1-29.

64 Pages Posted: 7 Nov 2018 Last revised: 28 Sep 2021

See all articles by Alla Petukhina

Alla Petukhina

HTW Berlin; Humboldt University of Berlin - Institute for Statistics and Econometrics

Simon Trimborn

City University of Hong Kong (CityU) - Department of Management Sciences; City University of Hong Kong (CityU) - School of Data Science

Wolfgang K. Härdle

Blockchain Research Center; Xiamen University - Wang Yanan Institute for Studies in Economics (WISE); Charles University; National Yang Ming Chiao Tung University; Humboldt University of Berlin - Center for Applied Statistics and Economics (CASE)

Hermann Elendner

Austrian Blockchain Center (ABC Research); UCL Centre for Blockchain Technologies

Date Written: October 23, 2020

Abstract

Cryptocurrencies (CCs) have risen rapidly in market capitalization over the last years. Despite striking price volatility, their high average returns have drawn attention to CCs as alternative investment assets for portfolio and risk management. We investigate the utility gains for different types of investors when they consider cryptocurrencies as an addition to their portfolio of traditional assets. We consider risk-averse, return-seeking as well as diversification-preferring investors who trade along with different allocation frequencies, namely daily, weekly or monthly. Out-of-sample performance and diversification benefits are studied for the most popular portfolio-construction rules, including mean-variance optimization, risk-parity, and maximum-diversification strategies, as well as combined strategies. To account for low liquidity in CC markets, we incorporate liquidity constraints via the LIBRO method. Our results show that CCs can improve the risk-return profile of portfolios. In particular, a maximum-diversification strategy (maximizing the Portfolio Diversification Index, PDI) draws appreciably on CCs, and spanning tests clearly indicate that CC returns are non-redundant additions to the investment universe. Though our analysis also shows that illiquidity of CCs potentially reverses the results.

Keywords: Cryptocurrency, CRIX, Investments, Portfolio Management, Asset Classes, Blockchain, Bitcoin, Altcoins, DLT

JEL Classification: C01, C58, G11

Suggested Citation

Petukhina, Alla and Petukhina, Alla and Trimborn, Simon and Härdle, Wolfgang K. and Elendner, Hermann, Investing with Cryptocurrencies – evaluating their potential for portfolio allocation strategies (October 23, 2020). Quantitative Finance (2021): 1-29., Available at SSRN: https://ssrn.com/abstract=3274193 or http://dx.doi.org/10.2139/ssrn.3274193

Alla Petukhina (Contact Author)

Humboldt University of Berlin - Institute for Statistics and Econometrics ( email )

Unter den Linden 6
Berlin, AK Berlin 10099
Germany

HTW Berlin ( email )

Treskowallee 8
Berlin, 10313
Germany

Simon Trimborn

City University of Hong Kong (CityU) - Department of Management Sciences ( email )

Tat Chee Avenue
Kowloon Tong
Kowloon
Hong Kong

City University of Hong Kong (CityU) - School of Data Science ( email )

Kowloon
Hong Kong

Wolfgang K. Härdle

Blockchain Research Center ( email )

Unter den Linden 6
Berlin, D-10099
Germany

Xiamen University - Wang Yanan Institute for Studies in Economics (WISE) ( email )

A 307, Economics Building
Xiamen, Fujian 10246
China

Charles University ( email )

Celetná 13
Dept Math Physics
Praha 1, 116 36
Czech Republic

National Yang Ming Chiao Tung University ( email )

No. 1001, Daxue Rd. East Dist.
Hsinchu City 300093
Taiwan

Humboldt University of Berlin - Center for Applied Statistics and Economics (CASE)

Unter den Linden 6
Berlin, D-10099
Germany

Hermann Elendner

Austrian Blockchain Center (ABC Research) ( email )

Favoritenstraße 111
Vienna, Vienna 1100
Austria

UCL Centre for Blockchain Technologies ( email )

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