CEF.UP – FIN Seminar/Webinar

Thursday – November 30^th, 2023 at 1:00 p.m. | Room 305| Online

Design risk: the curse of CPPIs

Raquel Gaspar– ISEG, Universidade de Lisboa

Abstract:

“This study underscores the notion that inadequately designed structured products or investment strategies have the potential to expose investors to unintended risks. Within this context, we introduce the concept of design risk into the portfolio insurance literature.

Specifically, our analysis focuses on Constant Proportion Portfolio Insurance (CPPI) structures and draws comparisons with classical Option-Based Portfolio Insurance (OBPI) as well as naive strategies like Stop-Loss Portfolio Insurance (SLPI) or CPPI with a multiplier set at one.

To assess the effectiveness of these strategies, we employ conditional Monte Carlo simulations to control the terminal value of the underlying asset. Our findings reveal a noteworthy phenomenon: even in scenarios where the terminal value of the underlying asset exceeds several times its initial value, CPPI strategies can lead to a cash-lock situation. The probability of getting cash-locked is influenced more by the multiplier’s magnitude and the investment horizon than by the dynamics of the underlying asset.”