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Assessing the Attractiveness of Cryptocurrencies in Relation to Traditional Investments in South Africa

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Assessing the Attractiveness of Cryptocurrencies in Relation to Traditional Investments in South Africa Assessing the attractiveness of cryptocurrencies in relation to traditional investments in South Africa A Dissertation presented to The Development Finance Centre (DEFIC) Graduate School of Business University of Cape Town In partial fulfilment of the requirements for the Degree of Master of Commerce in Development FinanceTown by LehlohonoloCape Letho LTHLEH001of February 2019 Supervisor: Dr Grieve Chelwa University The copyright of this thesis vests in the author. No quotation from it or information derivedTown from it is to be published without full acknowledgement of the source. The thesis is to be used for private study or non- commercial research purposes Capeonly. of Published by the University of Cape Town (UCT) in terms of the non-exclusive license granted to UCT by the author. University i PLAGIARISM DECLARATION I know that plagiarism is wrong. Plagiarism is to use another’s work and pretend that it is one’s own. I have used the American Psychological Association 6th edition convention for citation and referencing. Each contribution to, and quotation in, this dissertation from the work(s) of other people has been attributed, and has been cited and referenced. This dissertation is my own work. I have not allowed, and will not allow, anyone to copy my work with the intention of passing it off as his or her own work. I acknowledge that copying someone else’s assignment or essay, or part of it, is wrong, and declare that this is my own work. Signature________________ Date ____8 February 2019 _____________ ii ACKNOWLEDGEMENTS I would like to acknowledge my supervisor, Dr Grieve Chelwa for the thorough reviews that he provided me with on my research. I would like to thank him for stretching me during this process. I would also like to acknowledge Dr Abdul Latif Alhassan and the UCT GSB MCOM Development Finance programme team for all the guidance and lessons. Lastly, thank you, very much to my parents, my brother and cousins for the motivation, support and sacrifice. iii ABSTRACT The dissertation examined the effect of cryptocurrencies on the portfolio risk-adjusted returns of traditional and alternative investments using daily arithmetic returns from August 2015 to October 2018 of traditional assets (South African stocks, bonds, currencies), alternative assets (commodities, South African real estate) and cryptocurrencies (Cryptocurrency index (CRIX) and ten other individual cryptocurrencies). This is worth investigating as cryptocurrencies have been performing well while the listed equities in South Africa and most alternative investments have been underperforming (Srilakshmi & Karpagam, 2017). The mean-variance analysis, the Sharpe ratio, the conditional value-at-risk (CVaR) and the mean-variance spanning techniques were employed to analyse the data. The spanning test carried out was the multivariate ordinary least squares (OLS) regression Wald test. The research findings showed that the inclusion of cryptocurrencies in a portfolio of investments improves the efficient frontier of the portfolio of investments and the portfolio of investments risk-adjusted returns. Moreover, the findings suggested that cryptocurrencies are good portfolio diversification assets. However, investments in cryptocurrencies should be made with caution as the risks of investments are high in relation to traditional and alternative investments. The findings of this study advocate for individual and institutional investors to include cryptocurrencies within their South African portfolio of traditional and alternative investments. Keywords: Alternative assets; CRIX; Cryptocurrencies; Efficient frontier; Portfolio optimisation; Traditional assets iv TABLE OF CONTENTS PLAGIARISM DECLARATION ............................................................................................ i ACKNOWLEDGEMENTS ..................................................................................................... ii ABSTRACT ............................................................................................................................. iii LIST OF TABLES ................................................................................................................... vi LIST OF FIGURES ................................................................................................................ vii GLOSSARY OF TERMS ..................................................................................................... viii LIST OF ACRONYMS ............................................................................................................ x CHAPTER 1: INTRODUCTION ........................................................................................... 1 1.1. Background of the study .......................................................................................................... 1 1.1.1. How cryptocurrencies work ............................................................................................... 3 1.1.2. Advantages and disadvantages of cryptocurrencies ........................................................... 7 1.1.3. Bitcoin ................................................................................................................................ 9 1.1.4. South African market ....................................................................................................... 13 1.2. Problem statement definition ................................................................................................. 14 1.3. Statement of research objectives and hypotheses .................................................................. 15 1.3.1. Research assumptions ....................................................................................................... 16 1.4. Justification of the study ........................................................................................................ 17 1.5. Organisation of the study ....................................................................................................... 18 CHAPTER 2: LITERATURE REVIEW ............................................................................. 19 2.1. Introduction ............................................................................................................................ 19 2.2. Theories that guide the assessment of returns on assets......................................................... 19 2.2.1. Modern Portfolio Theory .................................................................................................. 19 2.2.2. Capital Asset Pricing Model ............................................................................................. 21 2.2.3. Efficient Market Hypothesis............................................................................................. 22 2.2.4. Behavioural Finance Theory ............................................................................................ 24 2.2.5. Adaptive Market Hypothesis ............................................................................................ 27 2.3. Empirical literature review ..................................................................................................... 28 2.3.1. Techniques used for assessing the performance of traditional investments ..................... 28 2.3.2. Literature that compares risks and returns of alternative assets to traditional assets ....... 32 2.3.3. Literature that assesses risks and returns of cryptocurrencies .......................................... 33 2.4. Conclusion and knowledge gap ............................................................................................. 36 CHAPTER 3: RESEARCH METHODOLOGY ................................................................. 38 3.1. Introduction ............................................................................................................................ 38 3.2. Research approach and strategy ............................................................................................. 38 3.3. Data collection and time period ............................................................................................. 39 v 3.4. Sampling and choice of data .................................................................................................. 40 3.5. Data analysis methods and analytical famework ................................................................... 40 3.5.1. Description and measurement of variables ....................................................................... 40 3.5.2. Empirical model and estimation approach ....................................................................... 42 3.6. Research reliability and validity............................................................................................. 47 3.7. Research limitations ............................................................................................................... 48 3.8. Ethical considerations ............................................................................................................ 49 3.9. Conclusion ............................................................................................................................. 49 CHAPTER 4: DISCUSSION OF FINDINGS ...................................................................... 51 4.1. Introduction ............................................................................................................................ 51 4.2. Trend analysis .......................................................................................................................
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