Rebalancing Return and Hedge Effectiveness of Dynamic Portfolio Insurance Strategies: A simulation Based Study

Abstract

Dynamic portfolio insurance strategies can be used to protect a stock market exposure against large losses. The implementation of these strategies entails a regular rebalancing which serves to adjust the current asset allocation to the one desired according to the strategy. An alternative to regular rebalancing could be a onetime portfolio allocation at the beginning of the investment period with no further adjustment up to the end of the period (“buy-and-hold”, B&H). An essential criterion for deciding on a portfolio insurance strategy is its performance in comparison to the B&H strategy.The aim of this paper is to study the performance of different dynamic portfolio insurance methodologies through a simulation process based on normally distributed stock returns. The analysis focuses on the Constant Proportion Portfolio Insurance (CPPI), Time Invariant Portfolio Protection (TIPP), and a modified version of the Time Invariant Portfolio Protection methodology (TIPP-M). The performance is measured using a rebalancing return and a hedge effectiveness measure. The results of the simulation analysis suggest that CPPI is the best strategy according to the rebalancing return while the TIPP strategy leads to the best hedge effectiveness results. TIPP-M is similar to TIPP but seems to be slightly worse.

Keywords: Portfolio insurance, Constant Proportion Portfolio Insurance, CPPI, Time Invariant Portfolio Protection, TIPP, Buy-and-Hold, Rebalancing Return, Hedge Effectiveness, Monte Carlo Simulation

JEL Classification: G11

DOI: 10.7176/RJFA

Publication Date:

DOI: 10.7176/RJFA/10-20-01

Publication date:October 31^st 2019