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Risk-weighted cryptocurrency indices

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  • Feng, Wenjun
  • Zhang, Zhengjun

Abstract

Current cryptocurrency indices are generally capitalization- or volume-weighted, assigning heavy weights to leading coins like Bitcoin. Such indices offer limited risk diversification and limited exposure to the success of altcoins. We propose the Smart Beta Indices of Cryptocurrencies (SBICs), which weight the components based on their dynamic risks and dependency structure. The SBICs provide better risk diversification, adding 0.13–0.31 Sharpe ratios and 24.42%–31.61% annualized returns over the cap-weighted index. The SBICs produce significant alphas using a cryptocurrency five-factor model that controls for exposures to the market, size, value, reversal, and betting-against-cryptocurrency-beta risks. Our results from the cryptocurrency market challenge a traditional opinion that smart beta outperformance generally results from the greater assumption of factor risks.

Suggested Citation

  • Feng, Wenjun & Zhang, Zhengjun, 2023. "Risk-weighted cryptocurrency indices," Finance Research Letters, Elsevier, vol. 51(C).
    • Handle: RePEc:eee:finlet:v:51:y:2023:i:c:s1544612322006158
    DOI: 10.1016/j.frl.2022.103438
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    More about this item

    Keywords

    Cryptocurrency; Smart beta; Index; Diversification; Factor model;
    All these keywords.

    JEL classification:

    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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