Rebalancing Premium in Cryptocurrencies
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The strategy utilizes the idea of a Rebalancing premium introduced by Willenbrock (2021). The paper argues that a simple buy-and-hold portfolio does not earn a diversification return. However, it generally has a lower variance than the weighted-average variance of its constituents. The cumulative return of a buy-and-hold portfolio is driven by the assets that perform the best and thus become a greater fraction of the portfolio. On the other hand, Willenbrock suggests the existence of a premium in a periodic rebalancing of uncorrelated assets. Additionally, the author emphasizes that reducing variance in a diversified portfolio is a necessary but not sufficient condition to earn a diversification return. Novel research further analyzes the rebalancing premium on the cryptocurrency market. The study found a significant premium in the periodic rebalancing of cryptocurrencies. Moreover, the paper compares the daily-rebalanced long-only portfolio to the long-short portfolio with various weights on the short side. Additionally, the paper analyzes the ability of the rebalancing premium of cryptocurrencies to improve the performance of low volatile assets such as bonds.
Fundamental reason
Rebalancing premium is defined as the premium an investor gains from periodically rebalancing their portfolio. For example, imagine having two assets with zero return and high volatility. If we buy just one, we are not going to earn anything. However, buying both and periodically rebalancing forces the investor to buy the asset that has decreased in relative value and sell the asset that has appreciated (thus taking profit) in relative value (as measured by their weights in the portfolio). As a result, the investor earns a so-called “rebalancing premium” or “diversification return.”
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Market Factors
Confidence in Anomaly's Validity
Period of Rebalancing
Number of Traded Instruments
Notes to Number of Traded Instruments
Complexity Evaluation
Financial instruments
Backtest period from source paper
Indicative Performance
Notes to Indicative Performance
Estimated Volatility
Notes to Estimated Volatility
Maximum Drawdown
Notes to Maximum drawdown
Sharpe Ratio
Regions
Simple trading strategy
The investment universe consists of 27 cryptocurrencies: BAT (Basic Attention Token), BTC (Bitcoin), BTG (Bitcoin Gold), DAI (Dai), DATA (Data Coin), DGB (DigiByte), EOS (EIS.io), ETH (Ethereum), FUN (FUN Token), IOTA (Iota), LRC (Loopring token), LTC (Litecoin), MANA (Mana coin), NEO (Neo), OMG (OMG, Formally known as OmiseGo), REQ (Request), SAN (Santiment Network Token), SNT (Status), TRX (Tron), WAX (Wax), XLM (Stellar), XMR (Monero), XRP (Ripple), XVG (Verge), ZEC (Zcash), ZIL (Zilliqa) and ZRX (0x). Two portfolios are created. The first portfolio is the daily rebalanced portfolio of all 27 cryptos to ensure that the assets have equal weights. The second portfolio is not rebalanced at all: an investor buys the equally-weighted crypto portfolio and lets the weights drift. Then the investor goes long the first portfolio and shorts the second portfolio with 70% weight. The ratio between first and second portfolio is daily rebalanced.
Hedge for stocks during bear markets
Unknown – Usually, cryptos are not a great diversifier since these assets are sensitive to crises. However, the strategy also has a significant short position in cryptocurrencies. Therefore, the risks seem to be lower. Moreover, thanks to the unique structure and rebalancing (taking profit) from rising cryptos, there indeed might be potential.
Out-of-sample strategy's implementation/validation in QuantConnect's framework(chart, statistics & code)
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Source paper
Hanicova, Daniela and Vojtko, Radovan, Rebalancing Premium in Cryptocurrencies
Abstract: This paper analyzes the rebalancing premium in cryptocurrencies. Rebalancing premium is defined as the premium an investor gains from periodically rebalancing their portfolio. Many papers examine this effect; however, very few to none study crypto markets.In the first section of this article, we generate 30 vectors, each with the mean daily return equal to 0 and daily volatility set to 7.5%, to simulate cryptocurrencies. Firstly, we created two portfolios, a buy and hold portfolio and a daily rebalanced portfolio. Multiple improvements can be observed when the portfolio is rebalanced periodically, including improved cumulative return and lowered volatility, resulting in a better Sharpe ratio. Moreover, the drawdowns are not as significant when applying daily rebalancing.The second section focuses on real data. We analyzed a portfolio consisting of 27 cryptocurrencies and compared daily- and monthly-rebalanced portfolios with benchmark buy-and-hold portfolio. We also compare the daily-rebalanced long-only portfolio to long-short portfolio with various weights on the short side.Moreover, in this section, we also consider the combination of cryptos with bonds. We assume that the volatility of cryptocurrencies combined with low volatile assets such as bonds could raise the overall performance while keeping the volatility at a reasonable level.Overall, we can say that there is a significant rebalancing premium in cryptocurrencies. Moreover, the crypto portfolio can also improve the performance of less volatile assets, such as bonds, when combined in a periodically rebalanced portfolio. Lastly, the functionality is based on a proposition that no single asset consistently outperforms the others. The rebalancing might not be as profitable in such a case.
Other papers
Willenbrock, Scott, Diversification Return, Portfolio Rebalancing, and the Commodity Return Puzzle
Abstract: Diversification return is an incremental return earned by a rebalanced portfolio of assets. The diversification return of a rebalanced portfolio is often incorrectly ascribed to a reduction in variance. We argue that the underlying source of the diversification return is the rebalancing, which forces the investor to sell assets that have appreciated in relative value and buy assets that have declined in relative value, as measured by their weights in the portfolio.In contrast, the incremental return of a buy-and-hold portfolio is driven by the fact that the assets that perform the best become a greater fraction of the portfolio. We use these results to resolve two puzzles associated with the Gorton and Rouwenhorst index of commodity futures, and thereby obtain a clear understanding of the source of the return of that index. Diversification return can be a significant source of return for any rebalanced portfolio of volatile assets.