Evaluation of Bitcoin as a hedge against the Ugandan market risk

Abstract

Bitcoin is the most popular cryptocurrency that has been in existence for over a decade. Originally created as a form of digital currency, Bitcoin's use cases have since varied with most users preferring Bitcoin as an asset rather than a currency. The price of Bitcoin has consistently surged to all-time highs and this has created excitement amongst its investors and some institutional investors are starting to allocate part of their investments to Bitcoin. This research project employs time-series analysis to evaluate Bitcoin as a hedge against the Ugandan Market risk through examining; 1. Bitcoin returns relative to the USE’s All Share Index (ALSI), Residential Property Price Index (RPPI), securities and Gold by using descriptive statistics, 2. Bitcoin’s hedging advantages against the ALSI by using the Pearson's correlation coefficient and, 3. Bitcoin’s diversification capabilities in a portfolio consisting of the ALSI, the RPPI, Gold, and Government securities by employing the Sharpe ratio. Time series secondary data for the period between January 2015 and December 2020 was used throughout the study. Findings from this research upheld those of previous studies that Bitcoin return benefits outweigh the risk exposure. Bitcoin Holding Period Returns were found to exceed those of other studied assets in multiples of over 57 units. Bitcoin returns were also regressed against those of the ASLI and it is noted that the two assets significantly have a weak relationship and thus, Bitcoin is a viable hedge tool against the Ugandan market risk. The study also upheld Bitcoin’s diversification benefits revealed in previous related studies. Using the Sharpe ratio, optimized portfolios containing Bitcoin are noted to yield a 30% average return in excess of each extra unit of risk undertaken; in comparison to portfolios excluding Bitcoin. The findings further reveal that an investor can optimize their risk exposure by allocating 2% of their investment to Bitcoin and 98% to Gold. This means that the investor must totally exclude the ALSI, Bonds and the RPPI to optimize the risk-return ratio. In conclusion, Bitcoin is found to be a viable hedge tool against the Ugandan market risk and possesses portfolio diversification capabilities. However, Gold is a better hedging and diversification tool due to the less volatility relative to Bitcoin.