Portfolio Optimization – Bitcoin & Downside Risk

Sammanfattning

The purpose of this paper is to analyze how the inclusion of cryptocurrency, specifically Bitcoin, affects downside risk in a diversified portfolio. The analysis utilizes a number of performance measures and combines Modern Portfolio Theory with a Post-Modern Portfolio Theory optimization in order to evaluate different portfolios. The portfolios are also benchmarked against a naive diversification portfolio. All of the included portfolios are evaluated on a time period starting from the 1 st of January 2015 and ending by the 31 st of March 2022. The results of this study show that Bitcoin can be utilized to obtain higher expected returns. Depending on the risk appetite of the investor, different weight of Bitcoin can be included in a portfolio. A Sharpe Ratio optimized Bitcoin portfolio exhibits 27,77 percentage points higher annual expected return than a Sharpe Ratio optimized portfolio excluding Bitcoin. However, the annual downside risk of the portfolio also increases by 6,87 percentage points when including Bitcoin. The results also show that a smaller weight of 7,5% allocated to Bitcoin can be advantageous compared to a Sharpe Ratio optimized portfolio excluding Bitcoin. The minor weight of Bitcoin improves the performance measures but demonstrates a slight decrease in expected return. This paper therefor concludes that Bitcoin can positively affect performance in a diversified portfolio, as long as it is balanced with major weights in less risky allocations, such as bonds.