Portfolio insurance with a dynamic floor

Abstract

Within the classic floor discipline of portfolio insurance, there exists a trade-off between upside capture and downside protection. However, portfolio insurance with a dynamic floor could improve the effectiveness of asset management. The dynamic floor principle states that when the stock price rises, investors freeze the floor and when the stock price decreases, investors increase the floor. On the basis of this principle, we propose the equal amount dynamic floor (EADF) discipline. Results from simulation and sensitivity analysis show that the EADF discipline outperforms the fixed floor discipline in both better downside protection and Sharpe ratios generation in the long run. © 2010 Macmillan Publishers Ltd.