Theory of constant proportion portfolio insurance

We study constant proportion portfolio insurance (CPPI), a dynamic strategy that maintains the portfolio's risk exposure a constant multiple of the excess of wealth over a floor, up to a borrowing limit. We use this simple rule to investigate how transaction costs and borrowing constraints affe...

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Bibliographic Details
Published in:Journal of economic dynamics & control 1992-07, Vol.16 (3), p.403-426
Main Authors: Black, Fischer, Perold, AndréF.
Format: Article
Language:English
Subjects:
Economic models
Economic theory
Expected returns
Insurance
Investment policy
Portfolio investments
Portfolio management
Put & call options
Studies
Utility functions
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Summary:We study constant proportion portfolio insurance (CPPI), a dynamic strategy that maintains the portfolio's risk exposure a constant multiple of the excess of wealth over a floor, up to a borrowing limit. We use this simple rule to investigate how transaction costs and borrowing constraints affect portfolio insurance-type strategies. Absent transaction costs, CPPI is equivalent to investing in perpetual American call options, and is optimal for a piecewise-HARA utility function with a minimum consumption constraint. As the multiple increases, the payoffs under CPPI approach those of a stop-loss strategy. The expected holding-period return is not monotonic in the multiple, and a higher expected return can be obtained under CPPI than with a stop-loss strategy.
ISSN:0165-1889
1879-1743
DOI:10.1016/0165-1889(92)90043-E