John-John Parma Christian Wassvik ________________________________ Should well-diversified portfolios contain cryptocurrencies? A quantitative analysis based on portfolio performance measures Masteroppgave i økonomi og administrasjon Handelshøyskolen ved OsloMet - storbyuniversitetet 2018 Abstract In this thesis we study whether cryptocurrencies should be included in a well-diversified portfolio or not. Moreover, we try to determine if the capital asset pricing model holds for cryptocurrencies, like other investments assets. We conclude that cryptocurrencies should be a part of a well-diversified portfolio. We make this conclusion based on the results from a selection of the most used financial performance metrics. We also conclude that the capital asset pricing model holds for cryptocurrencies. The data period we have looked at spans from 2010 and to the end of 2017, which is a relatively short time period and therefore a limitation in this study. Our results show that cryptocurrencies have been an excellent investment opportunity in the time period of our research. Outperforming the traditional assets, cryptocurrencies provides a better return considering the risk, either the systematic, unsystematic or whole risk. Handelshøyskolen ved OsloMet 2018 i Preface This master thesis concludes our financial studies in Business and Administration at Oslo Business School, Oslo Metropolitan University. As far as we know, this will be the first thesis on cryptocurrencies at Oslo Business School. We would first and foremost like to thank our supervisor Daniel Spiro for all his help and advice. His knowledge, encouragement and valuable academic support and feedback has been crucial. Furthermore, we would like to express our gratitude to Sturla Fjesme and Per Arne Tufte for valuable insights in various topics. We believe that cryptocurrencies are here to stay and therefore should be researched further and we want to contribute to that research field. Hopefully our research will intrigue other parties and future students to research the subject even further. We also hope that our thesis will increase the knowledge of others. This process has been challenging and time consuming, especially handling the vast amount of data in R-Studio and interpret it. Although being difficult, it has been a learning process and we have gained a lot of knowledge and experience in both the topic and data processing. Oslo Business School, May 2018 John-John Parma and Christian Wassvik ii Table of contents ABSTRACT ................................................................................................................................................... I PREFACE .................................................................................................................................................... II TABLE OF CONTENTS ................................................................................................................................. III 1 INTRODUCTION ................................................................................................................................. 1 1.1 MOTIVATION: ............................................................................................................................................ 1 1.2 RESEARCH QUESTION: ................................................................................................................................. 2 1.3 STRUCTURE OF THESIS ................................................................................................................................. 2 2 CRYPTOCURRENCIES: LITERATURE REVIEW AND GENERAL INFORMATION ........................................... 2 2.1 LITERATURE REVIEW .................................................................................................................................... 2 2.2 CRYPTOCURRENCY ...................................................................................................................................... 4 2.2.1 Bitcoin ............................................................................................................................................... 5 2.2.2 Altcoins ............................................................................................................................................. 7 2.2.3 Litecoin .............................................................................................................................................. 8 2.2.4 Ethereum .......................................................................................................................................... 8 2.3 CRYPTOCURRENCY, IS IT MONEY? .................................................................................................................. 9 2.4 RISK WHEN INVESTING IN CRYPTOCURRENCIES ................................................................................................ 10 2.5 PROS AND CONS WITH CRYPTOCURRENCY ...................................................................................................... 10 2.5.1 Pros ................................................................................................................................................. 11 2.5.2 Cons ................................................................................................................................................ 12 2.6 HOW TO ESTABLISH A NEW CURRENCY .......................................................................................................... 13 2.7 HOW MANY CRYPTOCURRENCIES IS TOO MANY? ............................................................................................. 15 2.8 FORKS .................................................................................................................................................... 16 2.9 PROOF-OF-WORK VS PROOF-OF-STAKE ......................................................................................................... 17 2.10 HOW TO STORE AND TRANSFER CRYPTOCURRENCY .......................................................................................... 17 3 METHODOLOGY ............................................................................................................................... 19 3.1 ANNUALIZED RETURNS ............................................................................................................................... 19 3.2 CAPITAL ASSET PRICING MODEL (CAPM)..................................................................................................... 20 3.2.1 Capital Asset Pricing Model Assumptions ...................................................................................... 21 3.2.2 Market risk premium ...................................................................................................................... 22 3.3 JENSEN’S ALPHA: ...................................................................................................................................... 22 3.4 TREYNOR RATIO: ...................................................................................................................................... 24 3.5 INFORMATION RATIO: ................................................................................................................................ 25 3.6 SHARPE RATIO:......................................................................................................................................... 26 3.7 OMEGA RATIO: ........................................................................................................................................ 27 iii 3.8 SORTINO RATIO: ....................................................................................................................................... 28 3.9 HONORABLE MENTIONS ............................................................................................................................. 29 3.10 WEAKNESSES AND LIMITATIONS .................................................................................................................. 30 4 DATA ............................................................................................................................................... 31 4.1 DATASET ................................................................................................................................................. 32 4.2 RISK-FREE INTEREST RATE ........................................................................................................................... 34 4.3 THE BENCHMARK, MSCI WORLD PRICE INDEX ............................................................................................... 34 4.4 VOLATILITY .............................................................................................................................................. 34 5 EMPIRICAL RESULTS ......................................................................................................................... 36 5.1 DESCRIPTIVE STATISTICS ............................................................................................................................. 36 5.2 SKEWNESS AND KURTOSIS .......................................................................................................................... 37 5.3 JARQUE-BERA TEST................................................................................................................................... 40 5.4 CORRELATION MATRIX ..............................................................................................................................