Asset Allocation with Cryptocurrencies

This research discusses the role of cryptocurrencies in portfolio investment and observes the timing within which the cryptos provide benefit to investors in a traditional financial market. We first use a mean-variance spanning test to check for any improvement that cryptos bring to a well-diversified portfolio and find a significant difference between port-folios with and without cryptos. Second, we analyze the weight dynamics of cryptos in the minimum-variance portfolio and the tangent portfolio to examine if cryptos present a hedging property in the mean-variance viewpoint. The finding shows that the optimal weights of cryptos increase distinctly in a market distress period, which shows their hedging property in a mean-variance view. Finally, we include cryptos in a well-diversified portfolio composed of common assets to check their weight dynamics in both tangent portfolio and minimum-variance portfolio. Consequently, we found that the cryptos take more weights in the tangent portfolio rather than in the minimum-variance portfolio, while the weights of cryptos increased in both portfolios during the COVID-19 pandemic; we thus conclude that cryptocurrencies can bring some hedging effect even in a portfolio with very common traditional assets. We also compare gold and cryptos and find that they have a similar pattern of weight dynamics, although gold has a slightly better effect in eliminating the downside risk of a minimum-variance portfolio.