Definition for : Portfolio insurance

A technique refined by Harry Leland and Mark Rubinstein in 1976 to provide partial protection for a portfolio of Shares against a drop in Value due to a drop in the Market, while at the same time, allowing the portfolio to increase in Value when Share prices rise. It is based on the use of Put options on Market indices (or a combination of Risk-free assets and Shares in order to create a synthetic Put option) which will hedge the portfolio against Risk. Portfolio Insurance requires ongoing mechanical and automated adjustment of the Hedging in line with Market fluctuations and is based on the assumption that it will always be possible to buy or sell Shares, which was not the case at the time of the 1987 crash which it was accused of aggravating.
(See Chapter 18 Risk and return of the Vernimmen)
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