Equilibrium Analysis of Portfolio Insurance

J. OF FINANCE, Vol. 51 No. 4, September 1996

Posted: 2 Jul 1996

See all articles by Sanford J. Grossman

Sanford J. Grossman

University of Pennsylvania - Finance Department; National Bureau of Economic Research (NBER)

Zongquan Zhou

Washington University in St. Louis

Abstract

A martingale approach is used to characterize general equilibrium in the presence of portfolio insurance. Insurers sell to non-insurers in bad states, and general equilibrium requires that the risk premium rises to induce non-insurers to increase their holdings. We show that portfolio insurance increases price volatility, causes mean reversion in asset returns, raises the Sharpe ratio and volatility in bad states, and causes volatility to be correlated with volume. We also explain why out-of-the-money S&P 500 put options trade at a higher volatility than do in-the-money puts.

JEL Classification: G22

Suggested Citation

Grossman, Sanford J. and Zhou, Zongquan, Equilibrium Analysis of Portfolio Insurance. J. OF FINANCE, Vol. 51 No. 4, September 1996. Available at SSRN: https://ssrn.com/abstract=7555

Sanford J. Grossman (Contact Author)

University of Pennsylvania - Finance Department ( email )

The Wharton School
3620 Locust Walk
Philadelphia, PA 19104
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Zongquan Zhou

Washington University in St. Louis

One Brookings Drive
Campus Box 1208
Saint Louis, MO MO 63130
United States

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