Portfolio optimization in the presence of tail correlation

We investigate the relative performance of optimal versus naive portfolio strategies. The accepted status on this question is that naive diversification outperforms optimal strategies. We revisit this question using U.S. data for equity, Treasury bonds, Gold and Crude Oil between 2002 and 2022 by analyzing the portfolio of investors displaying constant relative risk aversion who also consider tail behavior in the dynamics of assets. We use moment generating functions applied to non-Gaussian processes to obtain accurate model estimation as well as an efficient control variate for the utility maximization problem. Our results show that risk-averse investors that are aware of tail dynamics consistently outperform the most standard portfolio strategies. In particular, highly risk-averse investors substantially outperform the so-called naive 1/N portfolio in both pre-COVID-19 and post-COVID-19 periods. Thus, true portfolio diversification requires considering both the complexity of asset dynamics and realistic risk aversion structures. © 2023 Elsevier B.V.

Analysis of diversification benefits for cryptocurrency portfolios before and during the COVID-19 pandemic

Purpose>This study aims to investigate the diversification benefits attached to the crypto portfolios when combined with stocks, Forex instruments and commodity assets.Design/methodology/approach>Markowitz diversification techniques have been used to analyze the risk-return tradeoffs of the individual portfolios. Daily prices on cryptocurrencies and the selected asset classes, cover the period before and during the pandemic COVID-19. The portfolio risk of the portfolios was calculated by identical techniques and analyzed with equal criteria.Findings>The results with 270 trails indicate that stocks on average reduce the portfolio risk of crypto portfolios by 36% followed by fiat currency with 30.9% and commodities by 20.8%. Average daily returns stand in line with the standard portfolio theories where riskier portfolios offer higher returns and the other way around.Originality/value>The authors contribute to the current literature by investigating the portfolio risk attached to the crypto portfolios when stocks, commodities and Forex instruments were added separately. To this end, results inform not only retail investors but also portfolio managers on the asset classes that generate better optimization for crypto portfolios.