Humboldt-Universität zu Berlin - High Dimensional Nonstationary Time Series

IRTG1792DP2018 058

Investing with cryptocurrencies - evaluating the potential of portfolio allocation strategies

Alla Petukhina
Simon Trimborn
Wolfgang Karl Härdle
Hermann Elendner

The market capitalization of cryptocurrencies has risen rapidly during the
last few years. Despite their high volatility, this fact has spurred growing
interest in cryptocurrencies as an alternative investment asset for portfolio and
risk management. We characterise the effects of adding cryptocurrencies in addition
to traditional assets to the set of eligible assets in portfolio management.
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 the frequently low liquidity of cryptocurrency markets
we incorporate the LIBRO method, which gives suitable liquidity constraints.
Our results show that cryptocurrencies can improve the risk-return profile of
portfolios. In particular, cryptocurrencies are more useful for portfolio strategies
with higher target returns; they do not play a role in minimum-variance
portfolios. However, a maximum-diversification strategy (maximising the Portfolio
Diversification Index, PDI) draws appreciably on cryptocurrencies, and
spanning tests clearly indicate that cryptocurrency returns are non-redundant
additions to the investment universe.

cryptocurrency, CRIX, investments, portfolio management, asset
classes, blockchain, Bitcoin, altcoins, DLT

JEL Classification:
C01, C58, G11