Assets' Dependence Structure Implications for Portfolio Insurance
27 Pages Posted: 26 Sep 2018
Date Written: September 4, 2018
Portfolio insurance strategies that control benchmark-underperformance risk require estimating the maximum multiplier of the risk budget, which determines the allocation to the performance-seeking asset (PSA) at each point in time. We explore the implications of taking into account the expected co-movements of the PSA and the benchmark asset for the estimation of the multiplier of these portfolio insurance strategies. We illustrate these implications with a maximum relative-drawdown strategy investing in the equal-weighted S&P 500 index as the PSA and in the cap-weighted S&P 500 index as the benchmark asset. Through Monte Carlo simulations we find that the multiplier almost doubles in size across scenarios, and the long-term returns of the strategy using this approach are superior relative to the strategy with a multiplier that ignores expected co-movements according to stochastic dominance tests.
Keywords: tracking error, extreme risk management, copulas, portfolio insurance
JEL Classification: C58, G00, G17, C11
Suggested Citation: Suggested Citation