On the Optimality of Portfolio Insurance

Authors

  • SIMON BENNINGA,

  • MARSHALL BLUME

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    • Jerusalem School of Business, Hebrew University, Israel and the Finance Department, The Wharton School, University of Pennsylvania, respectively. We wish to thank Gunther Francke, Bruce Jacobs, and Richard Rogalski for helpful discussions on this topic. All errors are, of course, ours.


ABSTRACT

This paper examines the optimality of an insurance strategy in which an investor buys a risky asset and a put on that asset. The put's striking price serves as the insurance level. In complete markets, it is highly unlikely that an investor would utilize such a strategy. However, in some types of less complete markets, an investor may wish to purchase a put on the risky asset. Given only a risky asset, a put, and noncontinuous trading, an investor would purchase a put as a way of introducing a risk-free asset into the portfolio. If, in addition, there is a risk-free asset and the investor's utility function displays constant proportional risk-aversion, then the investor would buy the risk-free asset directly and not buy a put. In sum, only under the most incomplete markets would an investor find an insurance strategy optimal.

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