Research and publications

Measuring and Managing the Opportunity Cost of Downside Risk Protection

The Journal of Portfolio Management November 2021, Vol. 47, Issue 10 Special Real Estate Issue 2021.

Portfol ...


Nicole Beevers, Hannes Du Plessis, Lionel Martellini and Vincent Milhau


The Journal of Portfolio Management November 2021, Vol. 47, Issue 10 Special Real Estate Issue 2021.

Portfolio insurance targets the elimination of losses in excess of a predefined threshold while allowing for access to the upside potential of an underlying risky asset. This article studies the implications of the choice of the underlying asset on the frequency and magnitude of floor breaches and on the loss of performance associated with the protection against downside risk; it considers in particular the use of a diversified portfolio of stocks as opposed to a single stock.

The authors find that gap risk is more prominent when insurance is applied to a stock than to a portfolio, but it can be reduced by implementing time-invariant portfolio protection or by letting the multiplier decrease when volatility rises. However, option-based insurance with dynamic option replication has a large probability of breaching, no matter the underlying asset. Among diversified portfolios, minimum variance portfolios minimize the opportunity cost of insurance, but the ranking of diversified portfolios in terms of long-term returns does not appear to be disturbed by insurance.

Key Findings

  • Floor breaches in a portfolio insurance strategy occur more frequently and larger if the risky asset of the strategy is a single stock than if it is a diversified portfolio of stocks.
  • Option-based portfolio insurance with dynamic replication of the option involves large gap risk, whether the risky asset is a single stock or a diversified portfolio.
  • The opportunity cost of insurance against downside risk, measured as the long-term return spread between the insured portfolio and its underlying risky asset, is minimized by taking the risky asset to be the minimum variance portfolio.


This research has benefited from the support of FirstRand in the context of the “Designing and Implementing Welfare-Improving Investment Solutions for Institutions and Individuals” research chair at EDHEC-Risk Institute. 

Type : Academic Publication
Date : 15/10/2021