The Impact of Large Portfolio Insurers on Asset Prices

Authors

  • R. GLEN DONALDSON,

  • HARALD UHLIG

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    • Donaldson is from the University of British Columbia and Uhlig is from Princeton University. This is a revised version of a paper previously entitled “Portfolio Insurance and Asset Prices”. For helpful comments and suggestions we thank Jonathan Berk, Ruth Freedman, Ron Giammarino, Alan Kraus, an anonymous associate editor of this journal, the managing editor René Stulz, and especially an anonymous referee. Any errors are, of course, our own.

ABSTRACT

We develop a simple model in which the presence of portfolio insurers in a market of risk-averse traders leads to multiple equilibria for the pricing of financial assets and can cause an increase in volatility, including insurance-induced price drops. We demonstrate, however, that centralized portfolio insurance firms may actually reduce, not increase, volatility, even if the existence of these firms increases the total amount of funds under insurance.

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