Re-Evaluating Cryptocurrencies’ Contribution to Portfolio Diversification – A Portfolio Analysis With Special Focus on German Investors

Abstract

In this paper, we investigate whether mixing cryptocurrencies to a German investor portfolio improves portfolio diversification. We analyse this research question by applying a (mean variance) portfolio analysis using a toolbox consisting of (i) the comparison of descriptive statistics, (ii) graphical methods and (iii) econometric spanning tests. In contrast to most of the former studies we use a (broad) customized, Equally-Weighted Cryptocurrency Index (EWCI) to capture the average development of a whole \textit{ex ante} defined cryptocurrency universe and to mitigate possible survivorship biases in the data. In our in-sample analysis we find that cryptocurrencies can improve portfolio diversification in a few of the analyzed windows from our dataset (consisting of weekly observations from 2014-01-01 to 2019-06-01). However, we cannot confirm this pattern as the normal case. By including cryptocurrencies in their portfolios, investors predominantly cannot reach a (significantly) higher efficient frontier. However, an additional out-of-sample analysis shows, that risk-bearing investors can benefit from the consideration of cryptocurrencies in their portfolio allocation eventhough the optimal portfolio weights were mostly small or even close to zero percent.

Keywords: Capital Allocation, Portfolio Diversification, Spanning-Tests Step-down-Tests, Cryptocurrencies, Transaction Costs

JEL Classification: C12, C13, C32, E22, G11