BEYOND THE HYPE: BITCOIN AND PORTFOLIO DIVERSIFICATION

Abstract

This study determines whether Bitcoin enhances portfolio diversification and serves as a valuable investment asset during the COVID-19 crisis. In particular, we evaluate the significance and magnitude of the risk price associated with Bitcoin’s returns based on the ICAPM and NARDL models. Three methodological approaches were employed. First, we use the Intertemporal Capital Asset Pricing Model (ICAPM) to assess the effect of Bitcoin on a portfolio comprising 25 Fama-French portfolios. Second, a Nonlinear Autoregressive Distributed lag (NARDL) model explores Bitcoin’s impact on cross-sectional variation within the Fama-French portfolios, capturing potential asymmetric responses to price changes. Finally, we determine Bitcoin’s risk premium using the Capital Asset Pricing Model (CAPM), the Fama-French three-factor model (FF3), and the Fama-French five-factor model (FF5). Bitcoin fails to provide significant diversification benefits for profitability factor (RMW), and exhibit insensitivity to value (HML) and investment (CMA). The NARDL model indicates a potential hedging role only during crypto market downturns. The factor models reveal that Bitcoin behaves differently than traditional assets, exhibiting low sensitivity to market risk and a negative relationship with the size premium, further supporting its potential for diversification within specific portfolio contexts. Our finding shows that Bitcoin can protect the 25 Fama-French portfolio when Bitcoin loses value.