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Publication Portfolio insurance and prospect theory investors. Popularity and optimal design of capital protected financial products

Type

Refereed Article

Year

2011

Author(s)

Hubert Dichtl
Wolfgang Drobetz

Journal

Journal of Banking and Finance

Volume

35

Pages

1683-1697

Research Area

Capital Markets
Risk Management

Keywords

Portfolio insurance strategies, Prospect theory, Monte Carlo simulation, Historical simulation, Financial product design

Abstract

Portfolio insurance strategies are used on both the institutional and the retail side of the asset management industry. While standard utility theory struggles to provide an explanation, this study justifies the popularity of portfolio insurance strategies in a behavioral finance context. We run Monte Carlo simulations as well as historical simulations for popular portfolio insurance strategies and benchmark strategies in order to evaluate the outcomes using cumulative prospect theory. Our simulation results indicate that most portfolio insurance strategies are the preferred investment strategy for a prospect theory investor. Moreover, the analysis provides insights into how portfolio insurance products should be designed and structured to meet the preferences of prospect theory investors as accurately as possible.

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