Behavioral portfolio insurance strategies
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Behavioral portfolio insurance strategies Marcos Escobar-Anel1
· Andreas Lichtenstern2 · Rudi Zagst2
© Swiss Society for Financial Market Research 2020
Abstract Portfolio insurance strategies that ensure a certain minimum portfolio value or floor such as the Constant Proportion Portfolio Insurance (CPPI) and the Option-based Portfolio Insurance are economically important and widely spread among the banking and insurance industries. In distress and volatile market environments, investors such as pension funds have a need to insure their portfolios against downside risk in order to meet certain future payments or liabilities. Non-anticipated shocks or negative interest rates, jumps, crashes, or overnight trading restrictions in stock prices could drop pension fund portfolios below desired levels (present value of pension obligations) making them underfunded with pension assets to pension liabilities ratio below 100%. In particular, within the current low interest rate environment, a high number of pension funds happen to be underfunded which is a severe practical problem. Because of such scenarios, there is a need for an investment strategy which covers both the case of funded and underfunded portfolios. This article introduces a novel strategy which generalizes the CPPI approach. It has the overall target of guaranteeing the investment goal or floor while participating in the performance of the assets and limiting the downside risk of the portfolio at the same time. We show that the strategy accounts for behavioral aspects of the investor such as distorted probabilities, a risk-averse behavior for gains, and a risk-seeking behavior for losses. The proposed strategy turns out to be optimal within the Cumulative Prospect Theory framework by Tversky and Kahneman (J Risk Uncertain 5(4):297–323, 1992). Keywords Portfolio insurance · Portfolio choice · Pension funds · Behavioral finance · S-shaped utility function · Probability distortion JEL Classification C61 · G11 · G41
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Marcos Escobar-Anel [email protected]
1
The University of Western Ontario, 1151 Richmond Street, London, Canada
2
Technical University of Munich, Parkring 11, Garching, Hochbrück, Germany
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M. Escobar-Anel et al.
1 Introduction Portfolio insurance strategies are economically important and vital in particular for pension funds who have to meet certain payments or liabilities in the future. Thereby, the downside risk of the investor’s portfolio is limited as an application guarantees a pre-specified minimum portfolio value, also called the floor. The Constant Proportion Portfolio Insurance (CPPI) and the Option-based Portfolio Insurance (OBPI) are two prominent examples. This article focuses on the CPPI strategy, a dynamic asset allocation strategy which was introduced by Perold (1986) for the fixed income asset class (see also Perold and Sharpe (1988)) and Black and Jones (1987) for equities. Additional analysis on CPPI can be found in Black and Rouhani (1989) and Black and Perold (1992). Most portfolio insurance strategies have two
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