Economics at your fingertips  

On Path–dependency ofConstant Proportion Portfolio Insurance strategies

João Carvalho, João Beleza Sousa and Raquel Gaspar ()

No 2019/94, Working Papers REM from ISEG - Lisbon School of Economics and Management, REM, Universidade de Lisboa

Abstract: This paper evaluates the path–dependency/independency of most widespread PortfolioInsurance strategies. In particular, we look at Constant Proportion Portfolio Insurance (CPPI)structures and compare them to both the classical Option Based Portfolio Insurance(OBPI)and naive strategies such as Stop-loss Portfolio Insurance (SLPI) or a CPPI with a multiplierof one. The paper is based uponconditional Monte Carlo simulations and we show that CPPI strategies with a multiplier higher than 1 are extremely path-dependent and that they can easilyget cash-locked, even in scenarios when the underlying at maturity can be worth much morethan initially. The likelihood of being cash-locked increases with the size of the multiplierand the maturity of the CPPI, as well as with properties of the risky underlying’s dynamics.To emphasize the path dependency of CPPIs,we show that even in scenarios where theinvestor correctly “guesses” a higher future value for the underlying, CPPIs can get cash-locked,losing the linkage to the risky asset.This cash-lock problem is specific of CPPIs, itgoes against its European-style nature of traded CPPIs, and it introduces into the strategy a risks not related to the underlying risky asset – a design risk.Design risk does not occur forpath-independent portfolio insurance strategies, like the classical case of OBPI strategies, norin naive strategies. This study contributes to reinforce the idea that CPPI strategies suffer froma serious design problem.

Keywords: Portfolio Insurance; CPPI; OBPI; SLPI; path-dependencies; cash-lock; Conditioned GBM Simulations (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-ias and nep-rmg
Date: 2019-09
References: View references in EconPapers View complete reference list from CitEc
Citations: Track citations by RSS feed

Downloads: (external link) (application/pdf)

Related works:
Working Paper: On Path–dependency of Constant Proportion Portfolio Insurance strategies (2016) Downloads
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link:

Access Statistics for this paper

More papers in Working Papers REM from ISEG - Lisbon School of Economics and Management, REM, Universidade de Lisboa ISEG - Lisbon School of Economics and Management, REM, R. Miguel Lupi, 20, LISBON, PORTUGAL.
Bibliographic data for series maintained by Sandra Araújo ().

Page updated 2019-11-24
Handle: RePEc:ise:remwps:wp0942019