Why is Portfolio Insurance Attractive to Investors?
28 Pages Posted: 9 Dec 2009 Last revised: 17 Dec 2009
Date Written: December 3, 2009
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: Suggested Citation