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RE: Modern Portfolio Theory for Cryptocurrencies- Efficient Frontier
I haven't been looking into MPT but have been examining my portfolio closely and trying to find the best way to allocate it. In my overall portfolio I'm treating crypto in a way similar to emerging markets.
However, the breakdsown of that small allocation is the hard part.
Hi @mcdform
I like the way you have compared cryptos to Emerging Markets (EM)! They share similar characteristics as they have high volatility (Std Dev) and differing levels of correlation to traditional assets.
The question of allocation is always a difficult one- it is entirely dependent on a person’s risk ability and risk tolerance. However, if you look at Emerging Market Capitalization as a % of World Market Cap, if I remember correctly, it was around 25%. Does this mean we should allocate 25% of our wealth to EM? I guess the answer is not as simple as is the case with cryptos.
As we are dealing with a very young and unregulated market, you should consider the following risk factors when considering allocation: Information Asymmetry, Lack of Transparency, Lack of Governance and Liquidity issues (with quite a few cryptos).
However, by using MPT, we can combine this new asset class with our traditional mix to enjoy higher returns while lowering the level of overall level risk associated compared with say just owning cryptocurrencies.
When generating the Efficient Frontier, you allocate the weights to each of the assets in the portfolio (see video 1), and it will allow you to review the model then choose the best portfolio that gives you the level of return you expect at certain volatility you can handle.
The videos are excellent as they teach you how to build an Efficient Frontier and show you the concepts at the same time.
Best Regards,
Shenobie