The Diversification Benefits of Cryptocurrency Asset Categories and Estimation Risk: Pre and Post COVID-19

97 Pages Posted: 3 Aug 2021

See all articles by Xinyu Huang

Xinyu Huang

University of Bath - School of Management

Weihao Han

University of Bath - School of Management

David Newton

University of Bath - School of Management

Emmanouil Platanakis

University of Bath - School of Management

Dimitrios Stafylas

University of York - The York Management School

Charles Sutcliffe

University of Reading - ICMA Centre

Date Written: July 28, 2021

Abstract

We examine the diversification benefits of cryptocurrency asset categories. To mitigate the effects of estimation risk, we employ the Bayes-Stein model with no short-selling and variance-based constraints. We estimate the inputs using lasso regression and elastic net regression, employing the shrunk Wishart stochastic volatility model and Gaussian random projection. We consider nine cryptocurrency asset categories, and find that all but two provide significant out-of-sample diversification benefits. The lower is investor risk aversion, the more beneficial are cryptocurrencies as portfolio diversifiers. During uncertain economic environments, such as the post-COVID-19 period, cryptocurrencies provide the same diversification benefits as in more stable environments. Our results are robust to different portfolio benchmarks, regression technique, transaction cost, portfolio constraints, higher moments and Black-Litterman models.

Keywords: Portfolios, Cryptocurrencies, Bayes-Stein, COVID-19, Lasso, Elastic net, Shrunk Wishart stochastic volatility, Gaussian random projection, Black-Litterman, Higher moments

JEL Classification: G11, G12

Suggested Citation

Huang, Xinyu and Han, Weihao and Newton, David and Platanakis, Emmanouil and Stafylas, Dimitrios and Sutcliffe, Charles M., The Diversification Benefits of Cryptocurrency Asset Categories and Estimation Risk: Pre and Post COVID-19 (July 28, 2021). Available at SSRN: https://ssrn.com/abstract=3894874 or http://dx.doi.org/10.2139/ssrn.3894874

Xinyu Huang

University of Bath - School of Management ( email )

Claverton Down
Bath, BA2 7AY
United Kingdom

Weihao Han

University of Bath - School of Management ( email )

Claverton Down
Bath, BA2 7AY
United Kingdom

David Newton

University of Bath - School of Management ( email )

Claverton Down
Bath, BA2 7AY
United Kingdom

Emmanouil Platanakis (Contact Author)

University of Bath - School of Management ( email )

Claverton Down
Bath, BA2 7AY
United Kingdom

Dimitrios Stafylas

University of York - The York Management School ( email )

Freboys Lane
Heslington
York, North Yorkshire YO10 5DD
United Kingdom

Charles M. Sutcliffe

University of Reading - ICMA Centre ( email )

Whiteknights Park
P.O. Box 242
Reading RG6 6BA
United Kingdom

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