HOW GOOD ARE PORTFOLIO INSURANCE STRATEGIES?

AbstractPortfolio insurance strategies are designed to achieve a minimum level of wealth while at the same time participating in upward moving markets. The most prominent examples of dynamic versions are option-based strategies with synthetic put and constant proportion portfolio insurance strategies. It is well known that, in a Black/Scholes type model setup, these strategies can be achieved as optimal solution by forcing an exogenously given guarantee into the expected utility maximization problem of an investor with CRRA utility function. The CPPI approach is attained by the introduction of a subsistence level, the OBPI approach stems from an additional constraint on the terminal portfolio value. We bring these results together in order to explain when and why OBPI strategies are better than CPPI strategies and vice versa. We determine the utility losses, which are caused by introducing a terminal guarantee into the unconstrained maximization approach. In addition, we focus on utility losses, which are due to market frictions such as discrete-time trading, transaction costs, and borrowing constraints.