Evaluating the Impact of Bitcoin on International Asset Allocation using Mean-Variance, Conditional Value-at-Risk (CVaR), and Markov Regime Switching Approaches

TL;DR

This paper evaluates how Bitcoin influences international portfolio optimization by comparing mean-variance, CVaR, and Markov regime switching methods, highlighting Bitcoin's diversification benefits and the importance of regime-based analysis.

Contribution

It introduces a Markov regime switching approach to better capture Bitcoin's impact on portfolios, addressing limitations of traditional linear models.

Findings

Bitcoin improves diversification in international portfolios

Two regimes identified: bear and bull states based on return characteristics

Markov approach captures non-linear, regime-dependent effects of Bitcoin

Abstract

This paper aims to analyze the effect of Bitcoin on portfolio optimization using mean-variance, conditional value-at-risk (CVaR), and Markov regime switching approaches. I assessed each approach and developed the next based on the prior approach's weaknesses until I ended with a high level of confidence in the final approach. Though the results of mean-variance and CVaR frameworks indicate that Bitcoin improves the diversification of a well-diversified international portfolio, they assume that assets' returns are developed linearly and normally distributed. However, the Bitcoin return does not have both of these characteristics. Due to this, I developed a Markov regime switching approach to analyze the effect of Bitcoin on an international portfolio performance. The results show that there are two regimes based on the assets' returns: 1- bear state, where returns have low means and high volatility, 2- bull state, where returns have high means and low volatility.