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IAPM
PGP17
Portf Manag Tools(Nov19)
DifficultieswithProtectivePuts
Notradedputsontheshareswewishtoinsure
Portf insuranceonamorecomplicatedbasketofassets
Putsareavailable,butnotwiththerequired
strike/expiry
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EnterBlackScholes formula
Black
BlackScholes
Scholes formulabesidesprovidingaformulafor
thepriceofanoption,alsotellsushowthatoptioncan
bereplicatedusingstocksandbonds.
Wewillusethispartoftheformulatoconstructa
portfolioinsurancestrategy
BlackScholes Putoptionpremiums
The price of a put (with strike K) in the BlackBlack
11/21/2014
ThusbuyingaPutisequivalentto
investingPV(K)xN(d2)inariskfreeasset
plus
investingS0 N(d1) inthestock.
BSformulagivesthecompletereplicationportfoliofor
theoption
Useofthisinmanagingaportfolio
Ifyouwanttobuyaspecificportfolioofassetsandand
aninsurancepolicyguaranteeingthatyourtotal
investmentwillnotbeworthlessthanK,youcan
achievethisbyinvestingacertainproportioninthe
portfolioandtheremaininginriskfreeassets.
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Supposeyoudecidetoinvest$1000inNFYstock
(currentlysellingatRs.56)andinprotectiveputsof
thestockwithanexercisepriceofRs.50,foraoneyear
period.
The stock pays no dividends; you are hoping for a large capital
gain at the end of the year, but you want to guard against
NFY
NFYss prices declining
SupposethatthereisnotradedputonNFY,howdo
youimplementatradingstrategythatwillbeapprox
equivalenttotheprotectiveput?
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PRNG PseudoRandomNumber
Generators
WhatgoesbehindRAND()PRNG
P d
d
b
Pseudo-random
numbers
Whatistheseedofarandomnumber?
Considerthis:Midsquaremethod(oneoftheearliestPRNG)
Xo=0.9876
9753537
Xo^2=0.97535376
X1= 0.5353
X1^2=0.28654609
X2=0.6546
X0istheseedofthisRandomnumbergenerator.
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11/21/2014
PortfolioPerformanceEvaluation(Nov20)
AdjustingReturnsforRisk
Thesimplestandmost
popularwaytoadjust
returnsforriskisto
comparetheportfolios
returnwiththereturns
onacomparison
universe(groupoffunds
orportfolioswithsimilar
riskcharacteristics)
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11/21/2014
IsQbetterthanP?
Should I transfer some of my funds from P to Q?
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WhichMeasureisAppropriate?
Itdependsoninvestmentassumptions
p
p
1) Iftheportfoliorepresentstheentireriskyinvestment,then
usetheSharpemeasure.
2)Iftheportfolioisoneofmanycombinedintoalarger
investmentfund,usetheJensenortheTreynor measure.
TheTreynor measureisappealingbecauseitweighsexcess
returnsagainstsystematicrisk.
i
i i k
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11/21/2014
FurtherReading
ReadCh.18,pages644647foranicehistorical
ReadCh.18,pages644 647foranicehistorical
perspectiveofPortfolioInsurance
InvestmentsandRiskManagement:
Aaron Brown: Building the wings on your way down
ImplicationsofMultifactormodelstopractice
Cochrane: Portfolio advice for multifactor world
(http://info.freeman.tulane.edu/breese714/Investments%20Spr
ing%202006/Readings/cochrane2.pdf)
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