Managing cash-in risk embedded in Portfolio Insurance strategies: a review

Abstract

A portfolio insurance strategy is a dynamic hedging process aiming to limit downside risk during a market downturn and allow the investor to obtain an equity market participation in the upside market. The biggest potential risk of implementing a portfolio insurance strategy is the so-called cash-in risk, i.e., the risk that the underlying asset registers huge drops before the portfolio can be rebalanced. In such cases, the value of the insured portfolio would fall below the floor (the insured capital), and the consequence is that the portfolio is fully monetized, not allowing the investor to recover the capital initially
invested. First, this paper reviews the main properties of the most important allocation algorithm, the so called Constant Proportion Portfolio Insurance
(CPPI), and how the cash-in risk embedded with this allocation strategy can be modeled and hedged. Secondly, it describes the main extensions of CPPI
proposed in the literature to improve its capability to reduce cash-in risk.