Cryptocurrencies in Optimized Portfolios: A Portfolio Theory Approach: The Portfolio Performance-enhancing Capabilities of Cryptocurrencies

Arnór Brynjarsson & Krístín Agústsdóttír

Student thesis: Master thesis


Since cryptocurrencies entered the investment scene, they have attracted substantial interest from investors, both retail and professional, governments and corporations. The foundation of this interest is twofold; first, cryptocurrencies differ from traditional investment assets in the way that they are not based on any tangible asset nor are associated with any government or monetary authority. The second foundation is that cryptocurrencies have since their surfacing had a monumentally high price appreciation and returns compared to other investment assets. However, the high returns have been combined with extreme volatility compared to other asset classes. These characteristics build the foundation of the research performed in this analysis which purpose is to add to the literature on cryptocurrencies as an investment asset by investigating the effect of adding a professionally computed index of cryptocurrencies to optimized portfolios of five asset classes and empirically testing whether portfolio performance can be enhanced when including the index in an out-of-sample setting. A large theoretical foundation of portfolio theory exists, mostly built on Markowitz (1952), which relies on two parameters: expected return and variances. This analysis is performed across six portfolio construction methods as well as three levels of risk aversion, to make the results as robust and applicable as possible. The period studied is from March 2016 to December 2021 and performance is measured in terms of annualized excess returns, annualized Sharpe Ratio, and annualized Sortino Ratio of the portfolios with and without an investment in cryptocurrencies. Five optimization techniques are employed: The Global Minimum Variance portfolio, the Tangency portfolio, the Optimal portfolio, the Bayes-Stein Optimal portfolio, the Risk Parity portfolio, as well as the Equally Weighted portfolio. The results show strong evidence for cryptocurrencies´ ability to enhance portfolio performance as all performance metrics considered increase when including an investment in cryptocurrencies across all portfolios constructed. On average, annualized excess returns increase by 69.87%, the annualized Sharpe Ratio increases by 31.44%, and the annualized Sortino Ratio increases by 56.73% across all portfolios. While these results point to a clear enhancement of portfolio performance, it is recommended that the study is revisited when more data is available for the returns of cryptocurrencies.

EducationsMSc in Finance and Investments, (Graduate Programme) Final ThesisMSc in Finance and Strategic Management, (Graduate Programme) Final Thesis
Publication date2022
Number of pages138
SupervisorsClaus Munk