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Investors’ Perspective on Portfolio InsuranceExpected Utility vs Prospect Theories

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  • Raquel M. Gaspar
  • Paulo M. Silva

Abstract

This study supports the use of behavioural finance to explain the popularity of portfolio insurance. Portfolio insurance strategies are important financial solutions sold to institutional and individual investors, that protect against downside risk while maintaining some upside valuation potential. The way some of these strategies are engineered has been criticised, and portfolio insurance itself blamed for increasing market volatility in depressed markets. Despite this, investors keep on buying portfolio insurance that has a solid market share. This study contributes to understand the phenomenon. We compare investors' decision using two distinct frameworks: expected utility theory and behavioural theories. Based upon Monte Carlo simulation techniques we compare portfolio insurance strategies against uninsured basic benchmark strategies. We conclude that cumulative prospect theory may be a viable framework to explain the popularity of portfolio insurance. However, among portfolio insurance strategies, naive strategies seem to be preferable to most commonly traded strategies.

Suggested Citation

  • Raquel M. Gaspar & Paulo M. Silva, 2019. "Investors’ Perspective on Portfolio InsuranceExpected Utility vs Prospect Theories," Working Papers REM 2019/92, ISEG - Lisbon School of Economics and Management, REM, Universidade de Lisboa.
    • Handle: RePEc:ise:remwps:wp0922019
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    References listed on IDEAS

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    More about this item

    Keywords

    portfolio insurance·expected utility·prospect theory·Monte Carlo simulation;

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation

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