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Cryptocurrencies (CCs) have risen rapidly in market capitalization over thelast years. Despite striking price volatility, their high average returns havedrawn attention to CCs as alternative investment assets for portfolio and riskmanagement. We investigate the utility gains for different types of investorswhen they consider cryptocurrencies as an addition to their portfolio oftraditional assets. We consider risk-averse, return-seeking as well asdiversificationpreferring investors who trade along different allocationfrequencies, namely daily, weekly or monthly. Out-of-sample performance anddiversification benefits are studied for the most popularportfolio-construction rules, including mean-variance optimization,risk-parity, and maximum-diversification strategies, as well as combinedstrategies. To account for low liquidity in CC markets, we incorporateliquidity constraints via the LIBRO method. Our results show that CCs canimprove the risk-return profile of portfolios. In particular, amaximum-diversification strategy (maximizing the Portfolio DiversificationIndex, PDI) draws appreciably on CCs, and spanning tests clearly indicate thatCC returns are non-redundant additions to the investment universe. Though ouranalysis also shows that illiquidity of CCs potentially reverses the results.

Investing with Cryptocurrencies -- evaluating their potential for portfolio allocation strategies