Re-evaluating cryptocurrencies' contribution to portfolio diversification -- A portfolio analysis with special focus on German investors

TL;DR

This study assesses whether adding cryptocurrencies to German investors' portfolios enhances diversification, using a broad index and rigorous analysis methods, finding limited evidence of consistent diversification benefits.

Contribution

It introduces a customized, broad Equally-Weighted Cryptocurrency Index to mitigate survivorship bias and provides a comprehensive portfolio analysis with robust econometric tests.

Findings

Cryptocurrencies improve diversification in some periods but not consistently.

Including cryptocurrencies does not significantly raise the efficient frontier.

Results remain stable even when accounting for transaction costs and non-normal returns.

Abstract

In this paper, we investigate whether mixing cryptocurrencies to a German investor portfolio improves portfolio diversification. We analyse this research question by applying a (mean variance) portfolio analysis using a toolbox consisting of (i) the comparison of descriptive statistics, (ii) graphical methods and (iii) econometric spanning tests. In contrast to most of the former studies we use a (broad) customized, Equally-Weighted Cryptocurrency Index (EWCI) to capture the average development of a whole ex ante defined cryptocurrency universe and to mitigate possible survivorship biases in the data. According to Glas/Poddig (2018), this bias could have led to misleading results in some already existing studies. We find that cryptocurrencies can improve portfolio diversification in a few of the analyzed windows from our dataset (consisting of weekly observations from 2014-01-01 to 2019-05-31). However, we cannot confirm this pattern as the normal case. By including cryptocurrencies in their portfolios, investors predominantly cannot reach a significantly higher efficient frontier. These results also hold, if the non-normality of cryptocurrency returns is considered. Moreover, we control for changes of the results, if transaction costs/illiquidities on the cryptocurrency market are additionally considered.