Abstract
The purpose of this study is to investigate the potential of cryptocurrencies as a means to address diversification challenges within various African financial markets. Investors have increasingly shown interest in cryptocurrencies as a new asset class due to their high returns. This inquiry focuses on their integration into investment portfolios within the African context, aiming to enhance risk management and diversification. To achieve this objective, we propose a multi-objective portfolio optimization model, namely the mean-CVaR-entropy technique, which aims to maximize returns, minimize risk, and enhance diversification. This approach incorporates an entropy-maximizing objective, which sets it apart from traditional models like mean-variance and mean-CVaR.
We assess the performance of our model by comparing it with these traditional models, utilizing data from Africa's six largest stock market indices and six largest cryptocurrencies spanning from November 2017 to December 2022. Our results reveal that the mean-CVaR-entropy technique outperforms the mean-variance and mean-CVaR models, underscoring the diversification benefits inherent in the entropy-maximizing objective. These findings indicate the significance of alternative portfolio optimization strategies, such as the mean-CVaR-entropy model, in achieving well-diversified African stock portfolios. Furthermore, the study highlights the positive impact of integrating cryptocurrencies into regional portfolios, demonstrating their potential to enhance performance within African financial markets.
In conclusion, this study recommends the adoption of the mean-CVaR-entropy technique as a valuable tool for optimizing portfolios in the context of African financial markets. The model's demonstrated ability to enhance diversification and improve performance highlights its potential utility for investors operating within the region. Furthermore, we strongly recommend prioritizing investor education regarding diversification models and the potential risks and benefits of cryptocurrencies. Such education can be instrumental in optimizing portfolios and enhancing performance within African financial markets.