Bitcoin and a remarkably low correlation withBitcoin and a remarkably low correlation with

Bitcoin today
can be used to purchase almost anything from pizza deliveries to airplane
tickets. However, even for those not interested in Bitcoin as a payment system
to substitute real money, it is still important to explore its possibilities as
an investment vehicle. Whether Bitcoin is here to stay or not is in itself, as
previously discussed, a controversial topic. Regardless, with a record high
price of $10,330.80, reached on 28 November 2017, a market capitalization of $123.1
billion, and handling over 50,000 transactions daily (Bouri, Molnár, Azzi, Roubaud,
Hagfors, 2016), Bitcoin is an
interesting investment vehicle.

 

In 2015 Marie
Brière, Kim Oosterlink, and Ariane Szafarz conducted a study that used weekly
data from 2010-2013 to analyze Bitcoin from the standpoint of a U.S. investor
with a diversified portfolio including both traditional assets (stocks, bonds,
hard currencies) and alternative investments (commodities, hedge funds, real
estate). Through this analysis the researchers found that, at the time, Bitcoin
investments had high average returns, high volatility and a remarkably low
correlation with other assets. They concluded that bitcoin, to a certain
extent, could offer improved risk-return trade-offs in well-diversified
portfolios. However, one should take caution in accepting these findings as
they only took data from 2010 to 2013, which may apart from being an
extraordinarily small-time frame, also may reflect early-stage behavior why may
not last in the medium/long-run (Brière,
Oosterlinck, & Szafarz, 2015).

We Will Write a Custom Essay Specifically
For You For Only $13.90/page!


order now

 

Another study
conducted by Alexander Eisl, Stephan M. Gasser, and Karl Weinmayer (2015)
explored the impact that Bitcoin can have on an already well-diversified portfolio.
Interestingly, as a result of the non-normal nature of Bitcoin returns, the
researchers do not use a classic mean-variance approach to their analysis but
rather adopt a Conditional Value-at-Risk framework that does not require asset
returns to be normally distributed. The researchers found that even in already
well-diversified portfolios our optimizations lead to Bitcoin being included in
efficient portfolios with mean weights ranging from 1.65% to 7.69%. They
further concluded that Bitcoin will increase both the returns and risks faced
by an investor. However, the returns will increase by a higher proportion than
the risk, giving Bitcoin a place in a fully optimized portfolio (Eisl, Gasser, &
Weinmayer, 2015).

 

In 2015, Elie
Bouri, Peter Molnár, Georges Azzi, David Roubaud, Lars Hagfors examined whether
Bitcoin can act as a hedge and safe haven for major world stock indices, bonds,
oil, gold, the general commodity index, and the US dollar index. Using daily
and weekly data spanning from July 2011 to December 2015, the researchers made
use of a Dynamic Conditional Correlation model (Engle, 2002) to conclude that
Bitcoin can only serve as an effective diversifier for most of the cases but
cannot reliably function as a safe haven. One should note that this study is
limited due to Bitcoin prices’ high volatility during the sample period,
implying that the diversification ability of Bitcoin may not be consistent
overtime (Bouri et al.,
2017).

 

The majority of
papers published on the matter focus on descriptive
analysis of the Bitcoin network (Ron and Shamir, 2013), the potential risk of
double-spending (Karame, Androulaki,
and Capkun, 2012), the implications of the
availability of a public ledger containing all Bitcoin transaction ever made
(Meiklejohn, Pomarole,
Jordan, Levchenko, McCoy, Voelker, and Savage,
2013), and simply the mechanics and functioning behind Bitcoin (Grinberg,
2011). These previously described studies are largely representative of
the publicly available academic literature that takes a financial point of
view, namely the diversification potential, for Bitcoin. Without
fail, all these studies conclude that Bitcoin does offer diversification
potentials. However, these studies are not free of limitations. Amongst them
two stand out and can be improved upon: (1) The studies use data from limited
time frames due to Bitcoin being so young when written and only the most recent
provide data and conclusions post 2015; (2) All studies focus primarily on
Bitcoin while neglecting all other cryptocurrencies, therefore it is unclear
that cryptocurrencies.

 

Bearing this in mind, this paper will further build
upon the existing academic literature by providing a more up to date analysis,
and include not only Bitcoin but also the next biggest cryptocurrency,
Ethereum, in its analysis. Consequently, the following research question will
be investigated:

 

Does the inclusion of the two
largest cryptocurrencies – Bitcoin and Ethereum – offer additional
diversification benefits within an already well diversified portfolio?

 

The researcher identified the need of including the
next biggest cryptocurrencies in the analysis as Bitcoin only account for 75%
of the industry, however in combination with Ethereum (18%) the three

companies account for 93% of the industry in terms of
market capitalization (Coindesk,
2017). This
provides a more complete picture of the cryptocurrency industry and allows for
comparisons to be between the two cryptocurrencies.

 

According to Business Dictionary, diversification in an
investment setting is the “spreading of available funds over a wider selection
of types of investment, such as commodities, real estate, and securities
(Business Dictionary, n.d.). To insure one is diversifying properly, an
investor must select assets who’s returns, in large part, do not move together.
Therefore, much like the previously mentioned study by Brière et al. 2015, we must study the cryptocurrencies’
correlations with other assets in an already well diversified portfolio;
leading to the first hypothesis which will be tested: