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Effectiveness of CPPI strategies under discrete-time trading

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  • Balder, Sven
  • Brandl, Michael
  • Mahayni, Antje

Abstract

The paper analyzes the effectiveness of the constant proportion portfolio insurance (CPPI) method under trading restrictions. If the CPPI method is applied in continuous time, the CPPI strategies provide a value above a floor level unless the price dynamics of the risky asset permit jumps. The risk of violating the floor protection is called gap risk. In practice, it is caused by liquidity constraints and price jumps. Both can be modelled in a setup where the price dynamics of the risky asset are described by a continuous-time stochastic process but trading is restricted to discrete time. We propose a discrete-time version of the continuous-time CPPI strategies which satisfies three conditions. The resulting strategies are self-financing, the asset exposure is non-negative and the value process converges. We determine risk measures such as the shortfall probability and the expected shortfall and discuss criteria which ensure that the gap risk does not increase to a level which contradicts the original intention of portfolio insurance. In addition, we introduce proportional transaction costs and analyze their effects on the risk profile.

Suggested Citation

  • Balder, Sven & Brandl, Michael & Mahayni, Antje, 2009. "Effectiveness of CPPI strategies under discrete-time trading," Journal of Economic Dynamics and Control, Elsevier, vol. 33(1), pages 204-220, January.
    • Handle: RePEc:eee:dyncon:v:33:y:2009:i:1:p:204-220
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    5. Branger, Nicole & Mahayni, Antje & Schneider, Judith C., 2010. "On the optimal design of insurance contracts with guarantees," Insurance: Mathematics and Economics, Elsevier, vol. 46(3), pages 485-492, June.
    6. Sami Attaoui & Vincent Lacoste, 2013. "A scenario-based description of optimal American capital guaranteed strategies," Finance, Presses universitaires de Grenoble, vol. 34(2), pages 65-119.
    7. Olga Biedova & Victoria Steblovskaya, 2020. "Multiplier Optimization For Constant Proportion Portfolio Insurance (Cppi) Strategy," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 23(02), pages 1-22, March.
    8. Hambardzumyan, Hayk & Korn, Ralf, 2019. "Dynamic hybrid products with guarantees—An optimal portfolio framework," Insurance: Mathematics and Economics, Elsevier, vol. 84(C), pages 54-66.
    9. Ben Ameur, H. & Prigent, J.L., 2014. "Portfolio insurance: Gap risk under conditional multiples," European Journal of Operational Research, Elsevier, vol. 236(1), pages 238-253.
    10. Vanini, Paolo, 2012. "Fiancial Innovation, Structuring and Risk Transfer," MPRA Paper 42536, University Library of Munich, Germany.
    11. Marcos Escobar-Anel & Andreas Lichtenstern & Rudi Zagst, 2020. "Behavioral portfolio insurance strategies," Financial Markets and Portfolio Management, Springer;Swiss Society for Financial Market Research, vol. 34(4), pages 353-399, December.
    12. Peyman Alipour & Ali Foroush Bastani, 2023. "Value-at-Risk-Based Portfolio Insurance: Performance Evaluation and Benchmarking Against CPPI in a Markov-Modulated Regime-Switching Market," Papers 2305.12539, arXiv.org.
    13. Wentao Hu & Cuixia Chen & Yufeng Shi & Ze Chen, 2022. "A Tail Measure With Variable Risk Tolerance: Application in Dynamic Portfolio Insurance Strategy," Methodology and Computing in Applied Probability, Springer, vol. 24(2), pages 831-874, June.
    14. Schied, Alexander, 2014. "Model-free CPPI," Journal of Economic Dynamics and Control, Elsevier, vol. 40(C), pages 84-94.
    15. L. Di Persio & I. Oliva. K. Wallbaum, 2019. "Options on CPPI with guaranteed minimum equity exposure," Papers 1902.06505, arXiv.org.
    16. Zieling, Daniel & Mahayni, Antje & Balder, Sven, 2014. "Performance evaluation of optimized portfolio insurance strategies," Journal of Banking & Finance, Elsevier, vol. 43(C), pages 212-225.
    17. Jiang, Chonghui & Ma, Yongkai & An, Yunbi, 2009. "The effectiveness of the VaR-based portfolio insurance strategy: An empirical analysis," International Review of Financial Analysis, Elsevier, vol. 18(4), pages 185-197, September.
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    19. Busra Zeynep Temocin & Ralf Korn & A. Sevtap Selcuk-Kestel, 2018. "Constant proportion portfolio insurance in defined contribution pension plan management under discrete-time trading," Annals of Operations Research, Springer, vol. 260(1), pages 515-544, January.

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