One-Dimensional Pricing of CPPI

Louis Paulot and Xavier Lacroze

Papers from arXiv.org

Abstract: Constant Proportion Portfolio Insurance (CPPI) is an investment strategy designed to give participation in the performance of a risky asset while protecting the invested capital. This protection is however not perfect and the gap risk must be quantified. CPPI strategies are path-dependent and may have American exercise which makes their valuation complex. A naive description of the state of the portfolio would involve three or even four variables. In this paper we prove that the system can be described as a discrete-time Markov process in one single variable if the underlying asset follows a homogeneous process. This yields an efficient pricing scheme using transition probabilities. Our framework is flexible enough to handle most features of traded CPPIs including profit lock-in and other kinds of strategies with discrete-time reallocation.

Date: 2009-05, Revised 2010-02
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Persistent link: https://EconPapers.repec.org/RePEc:arx:papers:0905.2926

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