The Role of Cryptocurrencies in Investor Portfolios

Abstract

The role of cryptocurrencies as a vehicle for speculation has been well established. However, it is less clear if cryptocurrencies can also serve to manage risk. The authors seek to determine the diversification potential of cryptocurrencies both for short and long horizons. For short horizons, they estimate correlations that consider the direction and magnitude of returns for relevant asset classes, rather than focusing on full-sample correlations, as is customary. For long horizons, they compute “single period correlations” that capture the extent to which cryptocurrencies move synchronously with, or drift apart from, other assets over an investor’s horizon. They also identify utility-maximizing allocations to cryptocurrencies directly from historical return samples that account for all features of the data as well as more nuanced preferences than are typically assumed.