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Constructing Cointegrated Cryptocurrency Portfolios for Statistical Arbitrage

Last Updated on 10 February, 2024 by Rejaul Karim

The endeavor to strategically harness the dynamics of the cryptocurrency market takes center stage in “Constructing Cointegrated Cryptocurrency Portfolios for Statistical Arbitrage” by Tim Leung and Hung Nguyen. This insightful paper delves into the meticulous process of constructing cointegrated portfolios, employing a battery of statistical tests such as the Johansen cointegration test and Engle-Granger two-step approach.

The findings culminate in the formulation of cointegrated portfolios encompassing four prominent cryptocurrencies, with evocative potential for generating diverse trading strategies, contingent on distinct entry/exit thresholds and risk constraints.

Leveraging the all-encompassing methodology presented in this study, these portfolios offer a compelling prospect for optimized strategic positioning within the cryptocurrency landscape, holding promise for wider applicability in constructing novel cointegrated portfolios with diverse cryptocurrencies.

Abstract Of Paper

In this paper, we analyze the process of constructing cointegrated portfolios of cryptocurrencies. Our procedure involves a series of statistical tests, including the Johansen cointegration test and Engle-Granger two-step approach. Among our results, we construct cointegrated portfolios involving four cryptocurrencies: Bitcoin (BTC), Ethereum (ETH), Bitcoin Cash (BCH), and Litecoin (LTC). We develop a number of trading strategies under different entry/exit thresholds and risk constraints, and examine their performance in details through backtesting and comparison analysis. Our methodology can be applied more generally to create new cointegrated portfolio using other cryptocurrencies.

Original paper – Download PDF

Here you can download the PDF and original paper of Constructing Cointegrated Cryptocurrency Portfolios for Statistical Arbitrage.

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Author

Tim Leung
University of Washington – Department of Applied Math

Hung Nguyen
Computational Finance and Risk Management

Conclusion

In conclusion, “Constructing Cointegrated Cryptocurrency Portfolios for Statistical Arbitrage” by Tim Leung and Hung Nguyen offers a comprehensive framework for leveraging the strategic potential of the cryptocurrency market.

The meticulous process of constructing cointegrated portfolios, underpinned by rigorous statistical tests, yields diversified trading strategies encapsulating distinct entry/exit thresholds and risk constraints.

Through detailed backtesting and comparative analysis, the study unpacks the performance of these portfolios, surfacing their compelling potential for statistical arbitrage.

Additionally, the demonstrated methodology not only exhibits versatility in accommodating diverse cryptocurrencies but also lays the groundwork for the creation of new cointegrated portfolios. This study furnishes a pivotal roadmap for optimized strategic positioning within the cryptocurrency landscape, underscoring its relevance and potential applicability for constructing novel cointegrated portfolios with diverse cryptocurrencies.

Related Reading:

Learning and Predictability via Technical Analysis: Evidence from Bitcoin and Stocks with Hard-to-Value Fundamentals

Blockchain Characteristics and the Cross-Section of Cryptocurrency Returns

FAQ

Q1: What is the main focus of the research paper “Constructing Cointegrated Cryptocurrency Portfolios for Statistical Arbitrage” by Tim Leung and Hung Nguyen?

A1: The main focus of the research paper is to analyze the process of constructing cointegrated portfolios of cryptocurrencies. The study employs statistical tests, including the Johansen cointegration test and the Engle-Granger two-step approach, to develop cointegrated portfolios comprising four prominent cryptocurrencies: Bitcoin (BTC), Ethereum (ETH), Bitcoin Cash (BCH), and Litecoin (LTC). The goal is to provide a framework for constructing cointegrated portfolios and to examine various trading strategies based on these portfolios.

Q2: What statistical tests are used in the process of constructing cointegrated portfolios in the paper?

A2: The paper utilizes two main statistical tests: the Johansen cointegration test and the Engle-Granger two-step approach. These tests are employed to identify cointegration relationships among the selected cryptocurrencies, forming the basis for constructing cointegrated portfolios.

Q3: What cryptocurrencies are included in the cointegrated portfolios constructed in the study?

A3: The cointegrated portfolios constructed in the study include four prominent cryptocurrencies: Bitcoin (BTC), Ethereum (ETH), Bitcoin Cash (BCH), and Litecoin (LTC). These cryptocurrencies are analyzed to develop cointegrated portfolios for statistical arbitrage.

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