Premium
Equilibrium Analysis of Portfolio Insurance
Author(s) -
GROSSMAN SANFORD J.,
ZHOU ZHONGQUAN
Publication year - 1996
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1111/j.1540-6261.1996.tb04073.x
Subject(s) - volatility (finance) , sharpe ratio , economics , portfolio , portfolio insurance , post modern portfolio theory , mean reversion , stochastic volatility , martingale (probability theory) , financial economics , econometrics , monetary economics , replicating portfolio , portfolio optimization , mathematics , statistics
A martingale approach is used to characterize general equilibrium in the presence of portfolio insurance. Insurers sell to noninsurers in bad states, and general equilibrium requires that the risk premium rises to induce noninsurers to increase their holdings. We show that portfolio insurance increases price volatility, causes mean reversion in asset returns, raises the Sharpe ratio and volatility in bad states, and causes volatility to be correlated with volume. We also explain why out‐of‐the‐money S&P 500 put options trade at a higher volatility than do in‐the‐money puts.