A Comprehensive Evaluation of Portfolio Insurance Strategies

30 Pages Posted: 14 Jun 2011 Last revised: 25 Jun 2011

Jacques Pezier

University of Reading - ICMA Centre

Johanna Scheller

ICMA Centre, Henley Business School at Reading

Date Written: June 13, 2011

Abstract

We present a comprehensive framework for comparing the merits of alternative portfolio insurance strategies in realistic contexts. Our findings add generality to previous results comparing option based and constant proportionality portfolio insurance strategies (OBPI and CPPI). The optimal OBPI and CPPI payoffs are determined by maximizing expected utilities, with various degrees of risk sensitivity and over several investment horizons, using a general, two-parameter HARA utility. We consider two cases: either defined payoffs are purchased at fair prices or, as is typical in the implementation of portfolio insurance strategies, replicated discretely. The price dynamics of risky assets are modeled with either a geometric Brownian process or a time-changed geometric Brownian. Our results confirm the superiority of CPPI over OBPI in all cases. The effects of discrete replication and discontinuous price processes are examined by simulation and compared to the purchase at fair price of the theoretically optimal CPPI payoff when the underlying process is geometric Brownian.

Keywords: capital guaranteed products, constant proportionality portfolio insurance, option based portfolio insurance, jump processes, time-changed Brownian motion, dynamic replication, utility theory

JEL Classification: G11, G17

Suggested Citation

Pezier, Jacques and Scheller, Johanna, A Comprehensive Evaluation of Portfolio Insurance Strategies (June 13, 2011). Available at SSRN: https://ssrn.com/abstract=1864533 or http://dx.doi.org/10.2139/ssrn.1864533

Jacques Pezier

University of Reading - ICMA Centre ( email )

Whiteknights Park
P.O. Box 242
Reading RG6 6BA
United Kingdom

Johanna Scheller (Contact Author)

ICMA Centre, Henley Business School at Reading ( email )

Whiteknights Park
P.O. Box 242
Reading RG6 6BA
United Kingdom

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