Should Investors Include Bitcoin in Their Portfolios? A Portfolio Theory Approach
There has been a lot of anecdotal discussion around the volatility of the price of bitcoin and whether or not a bubble is currently present in cryptocurrencies. Much of this impassioned debate is based around speculative trading activities but what would be the outcome if we considered its place as part of a balanced portfolio of investments?
A working paper by Dr Andrew Urquhart, in collaboration with Emmanouil Platanakis of the University of Bath, examines whether investors should include Bitcoin in their portfolio. Including alternative investments in traditional portfolios has been an area of some debate in recent years, with some studies indicating that they add value (for instance Conover et al 2010; Gao and Nardari 2018), while some find that alternative investments offer no benefit to investors (for instance Daskalaki and Skiadopoulos 2011; Bessler and Wolff 2015).
In this paper, the authors employ eight popular asset allocation strategies to assess the out-of-sample benefits from holding some Bitcoin in a traditional stock-bond portfolio. They show that across all competing asset allocation strategies and levels of risk aversions, the benefits of including Bitcoin are quite considerable with substantially higher risk-adjusted returns. The authors also show that their results are robust to alternative estimation windows, the incorporation of transaction costs, the inclusion of commodities in the portfolio, and two additional portfolio optimization techniques that incorporate higher moments.
Since it was first proposed by Nakamoto in 2008, Bitcoin has received lots of attention from investors, the media and regulators. Bitcoin is the most popular cryptocurrency in terms of trading volume and is a peer-to-peer electronic cash system which allows online payments to be sent directly from one party to another without relying on a financial institution. Therefore, unlike the vast majority of other financial assets, Bitcoin has no association with any higher authority, such as a government, firm, country or commodity. Bitcoin also has no physical representation and its value is based on the security of an algorithm which is able to trace all transactions between buyers and sellers. The attention received is due to its low transaction costs, peer-to-peer system and governmental free design. This has led to a surge in trading volume, volatility and price, with cryptocurrencies regularly appearing in the mainstream news.
Therefore this research adds to the growing literature of cryptocurrencies by showing that Bitcoin is an attractive proposition for investors and should be considered by portfolio managers. The full working paper can be found at: https://ssrn.com/abstract=3215321.
Find out more about Dr Andrew Urquhart's research.