Felix Goltz, Lionel Martellini and Koray D. Simsek
Volume 6, Number 2, Second Quarter 2008
The focus of this paper is to determine what fraction a myopic risk-averse investor should allocate to investment strategies with convex exposure to stock market returns in a general economy with stochastically time-varying interest rates and equity risk premium. Our conclusion is that typical investors should optimally allocate a sizable fraction of their portfolio to such portfolio insurance strategies, and the associated utility gains are significant. While the fact that static investors would benefit from accessing dynamic investment strategies is in essence not surprising, we have found the size of the rational investment in such structures to be rather remarkable. This strong result is robust with respect to various parametric assumptions, as well as the presence of realistic levels of market frictions and heterogeneous expectations on volatility.