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Portfolio Optimization – Bitcoin & Downside Risk

Kraft, Vilgot LU (2022) NEKH02 20221
Department of Economics
Abstract
The purpose of this paper is to analyze how the inclusion of cryptocurrency, specifically Bitcoin, affects downside risk in a diversified portfolio. The analysis utilizes a number of performance measures and combines Modern Portfolio Theory with a Post-Modern Portfolio Theory optimization in order to evaluate different portfolios. The portfolios are also benchmarked against a naive diversification portfolio. All of the included portfolios are evaluated on a time period starting from the 1 st of January 2015 and ending by the 31 st of March 2022.

The results of this study show that Bitcoin can be utilized to obtain higher expected returns. Depending on the risk appetite of the investor, different weight of Bitcoin can be included in a... (More)
The purpose of this paper is to analyze how the inclusion of cryptocurrency, specifically Bitcoin, affects downside risk in a diversified portfolio. The analysis utilizes a number of performance measures and combines Modern Portfolio Theory with a Post-Modern Portfolio Theory optimization in order to evaluate different portfolios. The portfolios are also benchmarked against a naive diversification portfolio. All of the included portfolios are evaluated on a time period starting from the 1 st of January 2015 and ending by the 31 st of March 2022.

The results of this study show that Bitcoin can be utilized to obtain higher expected returns. Depending on the risk appetite of the investor, different weight of Bitcoin can be included in a portfolio. A Sharpe Ratio optimized Bitcoin portfolio exhibits 27,77 percentage points higher annual expected return than a Sharpe Ratio optimized portfolio excluding Bitcoin. However, the annual downside risk of the portfolio also increases by 6,87 percentage points when including Bitcoin. The results also show that a smaller weight of 7,5% allocated to Bitcoin can be advantageous compared to a Sharpe Ratio optimized portfolio excluding Bitcoin. The minor weight of Bitcoin improves the performance measures but demonstrates a slight decrease in expected return. This paper therefor concludes that Bitcoin can positively affect performance in a diversified portfolio, as long as it is balanced with major weights in less risky allocations, such as bonds. (Less)
Please use this url to cite or link to this publication:
author
Kraft, Vilgot LU
supervisor
organization
course
NEKH02 20221
year
type
M2 - Bachelor Degree
subject
keywords
Bitcoin, Portfolio Optimization, Conditional Value-at-Risk, Sharpe Ratio, Downside Risk
language
English
id
9082849
date added to LUP
2022-10-10 08:52:31
date last changed
2022-10-10 08:52:31
@misc{9082849,
  abstract     = {{The purpose of this paper is to analyze how the inclusion of cryptocurrency, specifically Bitcoin, affects downside risk in a diversified portfolio. The analysis utilizes a number of performance measures and combines Modern Portfolio Theory with a Post-Modern Portfolio Theory optimization in order to evaluate different portfolios. The portfolios are also benchmarked against a naive diversification portfolio. All of the included portfolios are evaluated on a time period starting from the 1 st of January 2015 and ending by the 31 st of March 2022.

The results of this study show that Bitcoin can be utilized to obtain higher expected returns. Depending on the risk appetite of the investor, different weight of Bitcoin can be included in a portfolio. A Sharpe Ratio optimized Bitcoin portfolio exhibits 27,77 percentage points higher annual expected return than a Sharpe Ratio optimized portfolio excluding Bitcoin. However, the annual downside risk of the portfolio also increases by 6,87 percentage points when including Bitcoin. The results also show that a smaller weight of 7,5% allocated to Bitcoin can be advantageous compared to a Sharpe Ratio optimized portfolio excluding Bitcoin. The minor weight of Bitcoin improves the performance measures but demonstrates a slight decrease in expected return. This paper therefor concludes that Bitcoin can positively affect performance in a diversified portfolio, as long as it is balanced with major weights in less risky allocations, such as bonds.}},
  author       = {{Kraft, Vilgot}},
  language     = {{eng}},
  note         = {{Student Paper}},
  title        = {{Portfolio Optimization – Bitcoin & Downside Risk}},
  year         = {{2022}},
}