Three-fund constant proportion portfolio insurance strategy

Chen, Ze and Chen, Bingzheng and Hu, Yi and Zhang, Hai (2019) Three-fund constant proportion portfolio insurance strategy. In: European Financial Management Association 2019 Annual Meeting, 2019-06-26 - 2019-06-29.

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Specific purpose guarantee funds (SPGFs) such as pension guarantee funds are becoming much popular among loss averse investors with common peculiar investment purpose, but receive few academic attention regarding to its investment strategy, hedging technique and performance. In this paper we propose a more practical constant proportion portfolio insurance (CPPI) strategy, three-fund CPPI (hereafter 3F-CPPI) strategy, which optimally allocates its assets in three funds: a risk-free fund, a stock-index fund and a purpose-related stock fund, to maximize the loss averse investor’s utility and to control the downside risk as well. Closed-form solutions of the optimal allocations of 3F-CPPI and its outcome distribution have been derived first under the continuous time case, followed by an extensive Monte Carlo simulation under the discrete time case to compare 3F-CPPI with other benchmark strategies such as CPPI. Our simulation results show that the proposed 3F-CPPI dominates other benchmark strategies in almost all the aspects such as the mean return, downside risk control and loss averse utility.