Portfolio diversification and dynamic hedging among BRICS stock markets and cryptocurrencies

Abstract

This present study explores the potential of cryptocurrencies in the diversification of a portfolio of rather integrated financial markets or instruments, such as BRICS by employing the mean-variance optimisation approach and the higher-order moments approach. The results indicate that while the theoretical implication of both the mean-variance approach and higher-order moments approach point in the same direction, the latter is more efficient in capturing the asymmetry and the tail risk of the returns, besides the investors' risk-aversion. The results suggest that ETH is the most popular cryptocurrency for portfolio diversification followed by BTC, almost receiving the same asset allocation in different portfolio optimisation strategies. The results also indicate that the potential of cryptocurrencies in portfolio diversification is rather marginal or limited to a risk-averse investor while they may offer an alternative investment avenue for risk-seeking investors. While cryptocurrencies may promise to offer a considerable diversification potential, the allocations to cryptocurrencies must conservatively be made, given the explosive price behaviour of cryptocurrencies in recent times.