PORTFOLIO INSURANCE STRATEGIES WHEN HEDGING AFFECTS SHARE PRICES

Option-based portfolio insurance can result in coordinated buying and selling, which destabilizes markets such that hedgers fail to achieve their objective. Gennotte and Leland (1990) show portfolio insurance s trategies can have an impact on price movements. Ramanlal and Mann (19 96) show how price movements, in turn, can alter hedging strategies. I n this paper, we combine these separate effects and develop an equilib rium, executable hedging strategy. This hedging strategy requires less rebalancing than traditional portfolio insurance; more important, it achieves downside protection with a less destabilizing impact on secur ity prices.