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Why is Portfolio Insurance Attractive to Investors?

28 Pages Posted: 9 Dec 2009 Last revised: 17 Dec 2009

Dennis Vrecko

University of Muenster - Finance Center Muenster

Nicole Branger

University of Muenster - Finance Center Muenster

Date Written: December 3, 2009

Abstract

This paper examines whether and how the popularity of portfolio insurance strategies can be justified theoretically. The analysis employs three different return generating processes with and without stochastic volatility and jumps. We find that an investor with constant relative risk aversion does not profit from portfolio insurance. For a cumulative prospect theory investor, on the other hand, the investment performance, measured by the certainty equivalent return, doubles from around 5% for buy-and-hold to around 10% due to portfolio insurance. Across all models, both loss aversion and probability weighting turn out to be crucial to explaining the attractiveness of portfolio insurance.

Keywords: cumulative prospect theory, portfolio planning, portfolio insurance, stochastic volatility, stochastic jumps

JEL Classification: D81, G13

Suggested Citation

Vrecko, Dennis and Branger, Nicole, Why is Portfolio Insurance Attractive to Investors? (December 3, 2009). Available at SSRN: https://ssrn.com/abstract=1519344 or http://dx.doi.org/10.2139/ssrn.1519344

Dennis Vrecko (Contact Author)

University of Muenster - Finance Center Muenster ( email )

Universitatsstr. 14-16
Muenster, 48143
Germany
+49 251 703 691 - 11 (Phone)
+49 251 703 691 - 20 (Fax)

HOME PAGE: http://www.wiwi.uni-muenster.de/fcm/finance/organisation/details.php?weobjectID=215

Nicole Branger

University of Muenster - Finance Center Muenster ( email )

Universitatsstr. 14-16
Muenster, 48143
Germany
+49 251 83 29779 (Phone)
+49 251 83 22867 (Fax)

HOME PAGE: http://www.wiwi.uni-muenster.de/fcm/fcm/das-finance-center/details.php?weobjectID=162

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