Mind the Floor: Enhance Portfolio Insurance without Borrowing

Abstract

Legal borrowing restrictions are generally claimed to limit portfolio insurance performance. We explore two alternative rebalancing rules that aim to pick up excess return subject to a borrowing constraint. One set of rules manages a volatility target for the risky assets, a second set of rules manages the floor. Considering real life trading conditions, our simulation results confirm that the borrowing constraint lowers average returns. The risk-adjusted performance however increases, so there is essentially nothing wrong with the legal prohibition to borrow. Still, managing the floor enhances risk-adjusted performance even more. Tweaking the volatility of the risky assets does not.

TOPICS: Legal/regulatory/public policy, portfolio construction, risk management, performance measurement