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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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    References listed on IDEAS

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    Cited by:

    1. Dangl, Thomas & Randl, Otto & Zechner, Josef, 2016. "Risk control in asset management: Motives and concepts," CFS Working Paper Series 546, Center for Financial Studies (CFS).
    2. Hamidi, Benjamin & Maillet, Bertrand & Prigent, Jean-Luc, 2014. "A dynamic autoregressive expectile for time-invariant portfolio protection strategies," Journal of Economic Dynamics and Control, Elsevier, vol. 46(C), pages 1-29.
    3. Weng, Chengguo, 2013. "Constant proportion portfolio insurance under a regime switching exponential Lévy process," Insurance: Mathematics and Economics, Elsevier, vol. 52(3), pages 508-521.
    4. 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.
    5. 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.
    6. 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.
    7. Schied, Alexander, 2014. "Model-free CPPI," Journal of Economic Dynamics and Control, Elsevier, vol. 40(C), pages 84-94.
    8. Vanini, Paolo, 2012. "Fiancial Innovation, Structuring and Risk Transfer," MPRA Paper 42536, University Library of Munich, Germany.
    9. 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.
    10. 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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