Optimizing portfolio diversification in the cryptocurrency era : a study of American and European markets

Abstract

Cryptocurrencies are gaining traction among investors, but their integration into traditional portfolios remains underexplored, especially across different geographic markets. Classical portfolio optimisation models make rigid assumptions about return distributions, market efficiency and investor rationality. This dissertation conducts a comparative analysis between American and European stock portfolios to examine if cryptocurrencies can improve returns and diversification. The study utilises naive diversification and Markowitz's modern portfolio theory to analyse the S&P 500 and the Euro Stoxx 50 indexes’ largest holdings with the top 5 cryptocurrencies by market capitalisation. The empirical findings reveal noticeable differences in how US and European markets respond to cryptocurrencies. Metrics like returns, volatility and Sharpe ratios substantially improve for European markets including cryptocurrencies, although aggressive optimisation overweights cryptocurrencies, increasing concentration risks. American markets demonstrate more conservative improvements, reflecting the inherent quality within US equities providing a strong foundation. Individual US tech stocks generate the highest standalone returns, although Bitcoin and Ethereum offer unrealized growth potential. The results contradict assumptions about international convergence in asset efficiency. Regional discrepancies can inform tailored geo asset allocations policies leveraging local dynamics. As the cryptocurrency ecosystem evolves, continual reevaluation of correlations, volatility and regulations remains imperative. This dissertation provides practical insights but has limitations including restricted samples, simplified trading assumptions and dependence on stringent modern portfolio theory conditions. Further research using multifaceted perspectives is warranted as innovation disrupts concepts of risk and return in global finance.