- Dynamic rebalancing strategies:
- Buy-and-hold: do nothing; no rebalance; linear payoff strategy.
- Constant-mix: buy stocks on fall, sell stocks on rise; rebalance frequently to maintain constant mix; concave payoff strategy.
- Constant-proportion portfolio insurance (CPPI): take no risk below a floor, establish a cushion and multiple to determine proportion to buy in stocks; buy stocks on rise, sell stocks on fall; ramp up risk quickly above floor; convex payoff strategy.
- Option-based portfolio insurance (OBPI): a variation of CPPI using call options and a specified time horizon.
- In trending markets (strong bull or bear), a linear (buy-and-hold) or convex (CPPI, OBPI) strategy is superior. In flat markets (reversals), a concave (constant-mix) strategy is superior.
- Concave payoff strategies 1) buy stocks on fall and sell stocks on rise, 2) generally have little downside protection, and 3) represent selling portfolio insurance.
- Convex payoff strategies: 1) buy stocks on rise and sell stocks on fall, 2) have explicit downside protection, and 3) represent buying portfolio insurance.
- Since concave and convex strategies are mirror images of each other (over buy-and-hold), the more popular one strategy is the higher the cost of implementing that strategy (since there will be less traders taking the opposite side).
Finished 10-Sep-08