Abstract
PurposeThis study investigates the role of cryptocurrencies in enhancing the performance of portfolios constructed from traditional asset classes. Using a long sample period covering not only the large value increases but also the dramatic declines during the beginning of 2018, the purpose of this paper is to provide a more complete analysis of the dynamic nature of cryptocurrencies as individual investment opportunities, and as components of optimal portfolios.Design/methodology/approachThe mean-variance optimization technique of Merton (1990) is applied to develop the risk and return characteristics of the efficient portfolios, along with the optimal weights of the asset class components in the portfolios.FindingsThe authors provide evidence that as a single investment, the best cryptocurrency is Ripple, followed by Bitcoin and Litecoin. Furthermore, cryptocurrencies have a useful role in the optimal portfolio construction and in investments, in addition to their original purposes for which they were created. Bitcoin is the best cryptocurrency enhancing the characteristics of the optimal portfolio. Ripple and Litecoin follow in terms of their usefulness in an optimal portfolio as single cryptocurrencies. Including all these cryptocurrencies in a portfolio generates the best (most optimal) results. Contributions of the cryptocurrencies to the optimal portfolio evolve over time. Therefore, the results and conclusions of this study have no guarantee for continuation in an exact manner in the future. However, the increasing popularity and the unique characteristics of cryptocurrencies will assist their future presence in investment portfolios.Originality/valueThis is one of the first studies that examine the role of popular cryptocurrencies in enhancing a portfolio composed of traditional asset classes. The sample period is the largest that has been used in this strand of the literature, and allows to compare optimal portfolios in early/recent subsamples, and during the pre-/post-cryptocurrency crisis periods.
Highlights
Cryptocurrencies are a basic topic of understanding to some, and a complete mystery to many
We focus on Bitcoin, Ripple and Litecoin because they have been in existence the longest
The portfolio with the traditional asset classes in equity, fixed income, real estate, along with the volatility index representing derivatives market for sophisticated investors is further enhanced with the cryptocurrencies, Bitcoin, Ripple and Litecoin
Summary
Cryptocurrencies are a basic topic of understanding to some, and a complete mystery to many. Throughout the past few years, these digital currencies have become the big thing for select investors, but a topic of complete confusion and question for others. Why have they become such a large topic for discussion as of recently? In the last quarter of 2017, this question was asked widely, as Bitcoin surged in value more than 2,500 percent from mid-December 2016 to mid-December 2017. In the course of one day, Bitcoin lost about 15 percent of its value, dropping from $13,500 to $11,500 in a matter of hours (Burgess, 2018). Bitcoin is the most well-known digital currency, it is just one of the more than 1,500 cryptocurrencies
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