PORTFOLIO INSURANCES, CPPI AND CPDO, TRUTH OR ILLUSION?

Elisabeth Joossens and Wim Schoutens
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Elisabeth Joossens: Joint Research Centre of the European Commission, Belgium
Wim Schoutens: Katholieke Universiteit Leuven, Department of Mathematics, Celestijnenlaan 200B, 3001 Leuven, Belgium

Chapter 11 in Alternative Investments and Strategies, 2010, pp 259-294 from World Scientific Publishing Co. Pte. Ltd.

Abstract: AbstractConstant proportion portfolio insurance (CPPI) and constant proportion debt obligations (CPDO) strategies have recently created derivative instruments, which try to protect a portfolio against failure events and have only been adopted in the credit market for the last couple of years. Since their introduction, CPPI strategies have been popular because they provide protection while at the same time they offer high yields. CPDOs were only introduced into the market in 2006 and can be considered as a variation of the CPPI with as main difference the fact that CPDOs do not provide principal protection. Both CPPI and CPDO strategies take investment positions in a risk-free bond and a risky portfolio (often one or more credit default swaps). At each step, the portfolio is rebalanced and the level of risk taken will depend on the distance between the current value of the portfolio and the necessary amount needed to fulfill all the future obligations.We first analyze in detail the dynamics of both investment strategies and afterwards test the safetyness of both products under a multivariate Lévy setting. More precise we first propose a quick way to calibrate a multivariate Variance Gamma (VG) process on correlated spreads, which can then be used to quantify the gap risk for CPPIs and CPDOs.

Keywords: Alternative Investments; Portfolio Selection; Trading Strategy; Product Innovations; CPPI; Portfolio Optimization; Portfolio Insurance (search for similar items in EconPapers)
Date: 2010
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