The payoff distribution model: an application to dynamic portfolio insurance

Abstract

We propose an innovative approach for dynamic portfolio insurance that overcomes many of the limitations of the earlier techniques. We transform the Payoff Distribution Model, originally introduced by Dybvig [ J . Business , 1988, 61 (3), 369-393] as a performance measure, into a fund management tool. This approach allows us to generate funds with pre-specified distributional properties. Specifically, we generate funds that are characterized by a Left Truncated Gaussian distribution and then demonstrate out of sample, using different performance and risk measures, that this approach to managing market exposure leads to a better risk control at a lower cost than more popular techniques such as the CPPI.