Assets’ Correlation Implications for Portfolio Insurance Strategies Performance

Summary:

The estimation of the multiplier parameter of portfolio insurance is crucial for this kind of investment strategies because it determines the risk exposure to the performance-seeking asset (PSA) at each point in time. Studies that address the estimation of the maximum multiplier of portfolio insurance strategies have been limited to the case in which the safe asset is a short-term bank account paying a constant rate of return. However, more general portfolio insurance strategies using a stochastic safe asset have important practical applications, such as the control of active-risk relative to a benchmark, as well as for the design of target retirement-income strategies. We explore the implications of taking into account the expected co-movements of the PSA and the benchmark asset for the estimation of the multiplier upper bound. In Monte Carlo simulations we find that the maximum multiplier almost doubles in size across scenarios, and the long-term returns of the strategy using this approach present stochastic dominance of order one to four over the previously tested strategies that used a multiplier that ignore expected co-movements.