Hedging the extreme risk of cryptocurrency

Abstract

The attractiveness of crypto investments is highlighted by their Sharpe ratios which are generally higher than that of similarly risky equity returns (MRP). However, this remarkable level of performance comes with significant risk. 1-week Value-at-Risk (VaR) losses indicate that cryptos’ potential 1-week losses were far more significant than MRP’s. This study provides new evidence showing that MRP is a meaningful diversifier of crypto risks. We also document that MRP reduces the downside risk of risk-averse investors at exactly the time it is needed, such as during periods of elevated levels of economic uncertainty.