Risk-averse Capital Market Line using Revised Option-Based Portfolio Insurance

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Rachid Bouchaib, United-Kingdom
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Summary:
Selecting a complete portfolio from Capital Market Line (CML) is the main asset allocation decision in efficient portfolio theory. A review of the literature reveals a lack of methodology, which can be used in practice to achieve a balance between investing in the risky portfolio and the risk-free asset. This has been a major challenge for many financial institutions such as insurance and pension funds especially in the aftermath of one of the most volatile periods in recent financial history. This article develops a methodology governing complete portfolio and CML construction based on a downside-risk framework using option pricing theory. Revised Option-based Portfolio Insurance (ROBPI) is a dynamic asset allocation process designed to maximise risky asset exposure with a downside protection. Linking ROBPI to efficient diversification theory leads to Risk- averse Capital Market Line function (RCML) assisting complete portfolios selection from CMLs depending on three parameters: risk aversion measure, risky asset volatility and duration of the investment period. An earlier version of this paper, Dynamic Asset Allocation To Hedge Cash Guarantees using Revised Option-Based Portfolio Insurance, was presented to the 2004 Finance & Investment Conference organised by the British Institute of Actuaries in Brussels.
 
Date: 1 June - Time: 14:15 to 15:45 - Room: 241
Theme: 1.B. Solvency measurements and asset-liability management