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.
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.”
Table on page 4, X = 70, assuming that only 1/10 of the portfolio is invested
Table on page 4, X = 70, assuming that only 1/10 of the portfolio is invested
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)
Table on page 4, X = 70, assuming that only 1/10 of the portfolio is invested
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.
Not known - 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.
