Is Bitcoin Good for Portfolio Diversification: Genetic Algorithm and Stochastic Dominance Approach

Abstract

This study aims to evaluate the effect of adding bitcoin in a diversified portfolio comprising traditional assets (bonds, European, Asian and international stock market indices) and alternative assets (gold and commodities) from an European investor point of view. Monthly data cover the period from August 2010 to March 2016. This period is divided into two sub-periods during the euro zone debt crisis and after the crisis. To do this, we will, first of all, apply the genetic algorithms method to optimize two types of portfolio with and without bitcoin for both subperiods. Next, we will compare the two optimal portfolios using the stochastic dominance approach during the two sub-periods. Genetic algorithms show that the weighting of bitcoin during the crisis is greater than that after the crisis, which proves that bitcoin has a safe haven value during unstable periods. The results of stochastic dominance show that during and after the crisis, the portfolio including bitcoin dominates the one without bitcoin according to the 2nd and 3rd order. This shows that risk-averse investors prefer to include bitcoin in their portfolios to maximize their expected utility.