Rebalancing Return and Hedge Effectiveness of Dynamic Portfolio Insurance Strategies: A simulation Based Study

Frieder Meyer-Bullerdiek

doi:10.7176/rjfa/10-20-01

Abstract

Dynamic portfolio insurance strategies can be used to protect a stock market exposure against large losses. The implementation of these strategies entails a regular rebalancing which serves to adjust the current asset allocation to the one desired according to the strategy. An alternative to regular rebalancing could be a onetime portfolio allocation at the beginning of the investment period with no further adjustment up to the end of the period (“buy-and-hold”, B&H). An essential criterion for deciding on a portfolio insurance strategy is its performance in comparison to the B&H strategy.The aim of this paper is to study the performance of different dynamic portfolio insurance methodologies through a simulation process based on normally distributed stock returns. The analysis focuses on the Constant Proportion Portfolio Insurance (CPPI), Time Invariant Portfolio Protection (TIPP), and a modified version of the Time Invariant Portfolio Protection methodology (TIPP-M). The performance is measured using a rebalancing return and a hedge effectiveness measure. The results of the simulation analysis suggest that CPPI is the best strategy according to the rebalancing return while the TIPP strategy leads to the best hedge effectiveness results. TIPP-M is similar to TIPP but seems to be slightly worse. Keywords: Portfolio insurance, Constant Proportion Portfolio Insurance, CPPI, Time Invariant Portfolio Protection, TIPP, Buy-and-Hold, Rebalancing Return, Hedge Effectiveness, Monte Carlo Simulation JEL Classification: G11 DOI : 10.7176/RJFA Publication Date : DOI : 10.7176/RJFA/10-20-01 Publication date :October 31 st 2019

Highlights

Not option-based dynamic portfolio insurance (PI) strategies are designed to protect portfolios against large falls by a contractually guaranteed predetermined floor through a dynamic allocation
This paper provides a performance evaluation of the Constant Proportion Portfolio Insurance (CPPI), Time Invariant Portfolio Protection (TIPP)- and Time Invariant Portfolio Protection methodology (TIPP-M)-techniques based on a Monte Carlo simulation
Apart from more traditional performance measures, this study considers the rebalancing return of the different approaches as well as the hedge effectiveness according to Johnson (1960) whereas the value at risk is used because this downside risk measure is more appropriate in a portfolio insurance context

Summary

Introduction

Not option-based dynamic portfolio insurance (PI) strategies are designed to protect portfolios against large falls by a contractually guaranteed predetermined floor through a dynamic allocation. Meyer-Bullerdiek and Schulz (2003) presented the so-called TIPP-M strategy which uses a variable multiple factor and where “M” in the title stands for “modified” This approach is characterized in that the cushion changes from one rebalancing period to the other and the multiplier (“m”) depending on the market trend. This multiplier of a certain period t (“Mt”) can be calculated e.g. for a certain stock portfolio according to the following equation RRH rpg rBg&H 1rp4g 44i 12w4i04 4ri3g 1rB4g&H4 4i 21 4wi40 4ri3g (5)

Volatility return

Number of observations

Rebalancing Return classes

Vmax Vmin

Findings

5.Conclusion