Dynamic Portfolio Optimization with Diversification Analysis and Asset Selection Amidst High Correlation Using Cryptocurrencies and Bank Equities

Abstract

There has been growing interest among investors to include cryptocurrencies in their portfolios because of their diversification potential. However, the diversification role of cryptocurrencies when added to South African bank equities is yet to be determined. This study rigorously evaluates asset co-movement and diversification benefits of integrating cryptocurrencies into South African bank equity portfolios. Using advanced financial engineering techniques, including multi-asset particle swarm optimizer (MA-PSO), random optimizer, and a static equal-weighted portfolio (EWP) model, this study analyzed the dynamic portfolio performance and diversification of cryptocurrencies in the 2017–2024 period. The portfolio performance of the three methods is also compared with the results from the traditional one-period mean–variance optimization (MVO) method. The findings underscore the superiority of dynamic models over static EWP in assessing the impact of cryptocurrency inclusion in bank equity portfolios. While pre-COVID-19 studies identified cryptocurrencies as effective hedges against market downturns, this protective role appears attenuated in the post-COVID-19 era. The dynamic MA-PSO model emerges as the optimal approach, delivering better-diversified portfolios. Consequently, South African portfolio managers must carefully evaluate investor risk tolerance before incorporating cryptocurrencies, with regulators imposing stringent guidelines to mitigate potential losses.