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Portfolio insurance and market crashes

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  • F Longin

    (CCF-DRI-DEFE)

Abstract

Portfolio insurance has traditionally taken two forms: the buying of put options and the dynamic replication of a given risk profile. While the first method often presents a prohibitive cost and lacks flexibility especially in terms of maturity choice, the second method does not always lead to the expected risk/return profile owing to market imperfections such as market illiquidity. This paper shows how new financial derivatives, referred to here as crash options, could be used to protect investors' portfolios during periods of extreme volatility against a sharp, large decline in the position value. A detailed empirical study is carried out for the US stock market using a database of daily return covering the period 1885–1999. Some results are also given for the European stock market over the recent period 1992–2001.

Suggested Citation

  • F Longin, 2001. "Portfolio insurance and market crashes," Journal of Asset Management, Palgrave Macmillan, vol. 2(2), pages 136-161, September.
    • Handle: RePEc:pal:assmgt:v:2:y:2001:i:2:d:10.1057_palgrave.jam.2240041
    DOI: 10.1057/palgrave.jam.2240041
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    Cited by:

    1. Kittiakarasakun, Jullavut & Tse, Yiuman, 2011. "Modeling the fat tails in Asian stock markets," International Review of Economics & Finance, Elsevier, vol. 20(3), pages 430-440, June.

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