Modeling Price Dynamics, Optimal Portfolios, and Option Valuation for Cryptoassets

Abstract

The authors demonstrate the construction of an optimal dynamic portfolio of cryptoassets that minimizes either return variance or conditional value at risk. One can view such a portfolio as a minimum-risk index for this asset class. They carefully backtested the dynamic portfolio model and developed a fair valuation model for options based on a dynamic pricing model for the underlying cryptoasset index. They obtain the valuation by passing from the natural world to the equivalent martingale measure via the Esscher transform. The work underscores the need for a cryptoasset index–based exchange-traded fund, the development of derivatives, particularly for cryptoportfolio insurance purposes, and the development of (nearly) riskless rates for this asset class. <b>TOPICS:</b>Currency, options, statistical methods, VAR and use of alternative risk measures of trading risk <b>Key Findings</b> ▪ This article provides a methodology for constructing an optimal dynamic portfolio of major cryptoassets that minimizes either return variance or conditional value at risk. ▪ The authors develop a fair valuation model for options based on a dynamic pricing model for the underlying cryptoindex. ▪ The work emphasizes the need for a cryptoasset index–based exchange-traded fund and the development of derivatives, in particular for cryptoportfolio insurance purposes.