Portfolio diversification with cryptocurrencies – Evidence from Middle Eastern stock markets

ABSTRACT The appealing features of cryptocurrency in the digital money sector have put them into the category of investable assets. Investment professionals have begun to consider their investability and diversification benefits. It is vital for investors to understand the return-risk behaviour among investable assets to reap the benefits of diversification. This paper considers a proxy of cryptos, specifically Bitcoin, Litecoin, Ethereum, Ripple & Neo, and the Middle East stock market indices, to examine the dynamic relationship among them using the vector error correction model. This study found evidence to suggest that cryptos exhibit a co-integrated relationship while there is no evidence of significant cointegrated movements occurring between the cryptos and the market indices. The latter finding implies that cryptos are decoupled from the market indices and can serve as a diversification option for investors. The mean-variance approach confirms that cryptocurrencies fit into an optimal portfolio and involve an enhanced return-risk reward for investors.