BITCOIN: Systematic Force of Cryptocurrency Portfolio

Tomić, Bojan (2020): BITCOIN: Systematic Force of Cryptocurrency Portfolio. Published in: Conference Proceedings - FEB Zagreb International Odyssey Conference on Economics & Business , Vol. 2, No. 1 (30 June 2020): pp. 384-398.

Abstract

Cryptocurrencies represent a new type of digital asset that cannot be linked to the framework of fundamental and systematic factors of existing financial instruments of the traditional capital market. Due to the lack of strictly defined fundamental indicators, supported by the results of research by the academic community, considering cryptocurrencies as investment opportunities can put investors in a subordinate position, a situation of complete uncertainty. Cryptocurrencies and their entire technical infrastructure are still a kind of unknown to the general public. Due to this, but also the lack of a regulatory framework, investors have to rely on sometimes uncertain information gathered through various media platforms. However, regardless of the type of assets and the mentioned shortcomings, when constructing a portfolio, investors should consider the dynamics of returns of potential components of the portfolio in order to identify and quantify the assumed investment risk and define the expected return. Cryptocurrencies are based on the idea of decentralization initially introduced by bitcoin blockchain technology and as such have their own historical sequence of origin. Since bitcoin is the first digital currency based on asymmetric cryptography, the change in its value can serve as a leading indicator of the movement of the cryptocurrency market as a whole. Accordingly, this paper will formally identify and describe the performance of the cryptocurrency portfolio with different optimization goals taking into account the assumption of a significant systematic impact of bitcoin cryptocurrency on the dynamics of the value of the aggregate secondary cryptocurrency market. For this purpose, six optimization targets will be formed: MinVar, MinCVaR, MaxSR, MaxSTARR, MaxUT and MaxMean. The results of the formed portfolios will be compared with the results of portfolios with the same allocation objectives, but which include a limitation on the impact of BTC as a systematic factor. The results suggest that by controlling the exposure by factor, better overall portfolio performance can be achieved through higher returns and Sharpe Ratio in four of the six implemented optimization strategies, while in terms of absolute risk measure five out of six portfolios achieved lower overall risk. Also, the obtained results confirm that the bitcoin transaction system plays a major role in defining the future movement of the value of the secondary cryptocurrency market.

• Item Type: MPRA Paper
• Language: English
• Keywords: cryptocurrencies, portfolio choice, factor investing, risk management, portfolio return
• Subjects: E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E49 - Other; G - Financial Economics > G1 - General Financial Markets > G11 - Portfolio Choice ; Investment Decisions; P - Economic Systems > P4 - Other Economic Systems > P45 - International Trade, Finance, Investment, and Aid

References

Bhambhwani, S., Delikouras, S. & Korniotis, G. M. (2020, April 15). Do Fundamentals Drive Cryptocurrency Returns? Retrieved from SSRN: https://ssrn.com/abstract=3342842 or http://dx.doi.org/10.2139/ssrn.3342842

Bouoiyour, J. & Selmi, R. (2015). What Does Bitcoin Look Like? Annals of Economics and Finance, 16 (2), 449-492

Brauneis, A. & Mestelb, R. (2018). Cryptocurrency-portfolios in a mean-variance framework. Finance Research Letters, (28), 259–264. Retrieved from https://doi.org/10.1016/j.frl.2018.05.008

Briere, M., Oosterlinck, K. & Szafarz, A. (2013). Virtual currency, tangible return: Portfolio diversication with bitcoins. Journal of Asset Management, (16) 6, 365–373. DOI:10.1057/jam.2015.5

Chuen, D. L. K., Guo, L. & Wang, Y. (2018). Cryptocurrency: A New Investment Opportunity? The Journal of Alternative Investments, (20) 3, 16–40. DOI: https://doi.org/10.3905/jai.2018.20.3.016

Cianan, P., Rajcaniova, M. & Kancs, D. A. (2016). The economics of BitCoin price formation. Applied Economics, 48 (19), 1799-1815. DOI: 10.1080/00036846.2015.1109038

Eisl, A., Gasser, S. & Weinmayer, K. (2015). Caveat emptor: Does bitcoin improve portfolio diversication? Working Paper, WU. Retrieved from SSRN: https://ssrn.com/abstract=2408997 or http://dx.doi.org/10.2139/ssrn.2408997

Hayes, A. (2015, March 16). What Factors Give Cryptocurrencies Their Value: An Empirical Analysis. Retrieved from SSRN: https://ssrn.com/abstract=2579445 or http://dx.doi.org/10.2139/ssrn.2579445

Kajtazi, A., & Moro, A. (2019). The role of bitcoin in well diversified portfolios: A comparative global study. International Review of Financial Analysis, (61), 143–157. Retrieved from https://doi.org/10.1016/j.irfa.2018.10.003

Khamisa, Z. (2019, April 30). An analysis of the factors driving performance in the cryptocurrency market. Do these factors vary significantly between cryptocurrencies? Retrieved from https://www.researchgate.net/publication/333967521. DOI: 10.13140/RG.2.2.31571.02089

Klein, T., Hien, P. & Walther, T. (2018). Bitcoin Is Not the New Gold: A Comparison of Volatility, Correlation, and Portfolio Performance, International Review of Financial Analysis, (59), 105-116. Retrieved from https://doi.org/10.1016/j.irfa.2018.07.010

Liu, W. (2018). Portfolio Diversification across Cryptocurrencies. Finance Research Letters, (29). 200-205. Retrieved from https://doi.org/10.1016/j.frl.2018.07.010

Markowitz, H. (1952). Portfolio selection. The journal of finance, (7) 1, 77-91. DOI:10.2307/2975974

Petukhina, A., Trimborn, S., Härdle, W. K. & Elendner, H. (2018, October 24). Investing With Cryptocurrencies – Evaluating the Potential of Portfolio Allocation Strategies. Retrieved from SSRN: https://ssrn.com/abstract=3274193 or http://dx.doi.org/10.2139/ssrn.3274193

Platanakis, E., Sutcliffeb, C. & Urquhartc, A. (2018). Optimal vs naïve diversification in cryptocurrencies. Economics Letters, (171), 93-96. Retrieved from https://doi.org/10.1016/j.econlet.2018.07.020

Renkens, M. (2018, July). Quantitative Factor Investing Strategies in the Cryptocurrency market. Retrieved from https://scripties.uba.uva.nl/document/670194

Rockafellar, R. T. & Uryasev, S. (2000). Optimization of conditional value-at-risk. Journal of risk, (2) 3, 21–42. DOI: 10.21314/JOR.2000.038

Škrinjarić, T. (2013). Mjerenje diversifikacije portfelja. Zbornik Ekonomskog fakulteta Sveučilišta u Zagrebu, (11) 1, 67-79. Retrieved from https://hrcak.srce.hr/104654

Trimborn, S., Li, M. & Härdle W. K. (2019). Investing with Cryptocurrencies—a Liquidity Constrained Investment Approach. Journal of Financial Econometrics, nbz016. Retrieved from https://doi.org/10.1093/jjfinec/nbz016

Zivot, E. (2016). Introduction to Computational Finance and Financial Econometrics with R. New York City: Springer