Diversification, Integration and Cryptocurrency Market

Abstract

We investigate the degree to which cryptocurrencies provide diversification benefits to an investor. We use a stochastic spanning methodology to construct optimal portfolios with and without cryptocurrencies, evaluating their comparative performance both inand out-of-sample. Empirical analysis seems to indicate that the expanded investment universe with cryptocurrencies dominates the traditional one with stocks, bonds and cash, yielding potential diversification benefits and providing better investment opportunities for some risk averse investors. We further explain our results by documenting that cryptocurrency markets are segmented from the equity and bond markets.

Keywords: Cryptocurrencies, Portfolio choice, Second order stochastic dominance, Stochastic spanning, Diversification, Market integration, Market segmentation

JEL Classification: C12, C14, D81, G11