 On the inefficiency of portfolio insurance and caveats to the mean/downside-risk frameworkAndre Lucas and Cees L. Dert No 57, Serie Research Memoranda from VU University Amsterdam, Faculty of Economics, Business Administration and Econometrics Abstract: Portfolio insurance strategies based on options typically treat the investment in the risky asset, e.g., stock, as fixed. We show in a mean/downside-risk framework that such a strategy is inefficient. Using at the money put options, expected returns can be increased by more than 250 basis points without taking on more risk. Gains can become arbitrarily large when one uses options with extremely high strike prices. This is due to a serious caveat to the mean/downside-risk framework that is typically adopted in the literature by substituting downside-risk measures for standard risk measures such as the variance of returns. These pathologic results vanish when one maximizes an appropriately chosen HARA utility function. In this framework, fixing the holding of the risky asset in advance leads to efficiency losses that vary between 250 and 650 basis points depending on the degree of risk aversion. Keywords: mean/downside-risk efficiency; option strategies; optimal portfolio choice; portfolio insurance; downside-risk. (search for similar items in EconPapers) Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:vua:wpaper:1998-57 Access Statistics for this paper More papers in Serie Research Memoranda from VU University Amsterdam, Faculty of Economics, Business Administration and Econometrics Contact information at EDIRC. |
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