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The diversification benefits of cryptocurrency asset categories and estimation risk: pre and post Covid-19

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  • Xinyu Huang
  • Weihao Han
  • David Newton
  • Emmanouil Platanakis
  • Dimitrios Stafylas
  • Charles Sutcliffe

Abstract

We examine the diversification benefits of cryptocurrency asset categories. To mitigate the effects of estimation risk, we employ the Bayes-Stein model with no short-selling and variance-based constraints. We estimate the inputs using lasso regression and elastic net regression, employing the shrunk Wishart stochastic volatility model and Gaussian random projection. We consider nine cryptocurrency asset categories, and find that all but two provide significant out-of-sample diversification benefits. The lower is investor risk aversion, the more beneficial are cryptocurrencies as portfolio diversifiers. During uncertain economic environments, such as the post-Covid-19 period, cryptocurrencies provide the same diversification benefits as in more stable environments. Our results are robust to different portfolio benchmarks, regression technique, transaction cost, portfolio constraints, higher moments and Black–Litterman models.

Suggested Citation

  • Xinyu Huang & Weihao Han & David Newton & Emmanouil Platanakis & Dimitrios Stafylas & Charles Sutcliffe, 2023. "The diversification benefits of cryptocurrency asset categories and estimation risk: pre and post Covid-19," The European Journal of Finance, Taylor & Francis Journals, vol. 29(7), pages 800-825, May.
    • Handle: RePEc:taf:eurjfi:v:29:y:2023:i:7:p:800-825
    DOI: 10.1080/1351847X.2022.2033806
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