Reasearch On Asset Allocation Strategy Under Return Guarantee

Because of the impact of financial crisis, the volatility of international financial markets increased, the rates of return continue to lower. It is difficult for investors to judge the future market trends, the consciousness of financial risk protection strengthen. Under this background, investors not only hope to ensure the safety of the principal when market prices fall ,but also hope to share the benefits of higher price when market price goes up. The new financial product characterized by return guarantee reduce the investment risk and increase the combinations of return,which is consistent with the investment philosophy that hope to avoid risk and seek return.thereby, financial product characterized by return guarantee are welcomed by investors.Financial products with return guarantees are generally risk aversion, Investors often want to get investment income security or social security by investing it. Therefore, financial products with return guarantees play an important role in the financial markets. The investment management of financial products with return guarantees directly affect the credibility of the investment institutions and investors profit, and indirectly affect the operation and development of securities markets and social stability. Based on the property of return guarantees, this paper makes use of some theories and methods synthetically, such as portfolio theory,option pricing theory,risk management theory, stochastic dynamic programme, martingale method and Monte Carlo simulation to study the return? guarantees from the view of asset allocation,cost and risk respectively.Main contents of this paper:1. This paper divides the study of return guarantees into three categories: optimal asset allocation under return guarantees,calculating the cost of return guarantees, calculating the risk of return guarantees.then, this paper summarizes the related research and achievements and points out the defect of existing literature.2. This paper considers optimal investment problem for guaranteed equity-linked notes based on the perspective of investment institutions. the optimal investment strategy can be converted to the optimal investment strategy under return guarantees. this paper describes how to apply stochastic optimal control method to optimal investment strategies, then, we obtain the solution of optimal investment strategies under the stochastic interest rate environment.3. This paper depicts the necessity of return guarantee,and introduce successful experience of constructing return guarantees mechanism in Eastern Europe and Latin America.then,describes the application of martingale method in the optimal investment strategy.Based on the fact that a more flexible return guarantees is widely used currently in pension fund. Using martingale method, we derive the explicit solution of optimal investment strategy under flexible return guarantee.Finally, based on the fact that many pension fund manager set return guarantee upper limit, this paper obtains the solution of optimal investment strategy under return guarantee upper limit from the perspective of pension fund investment institutions,using stochastic optimal control method.4. This paper points out that available papers study the value of return guarantees without considering asset allocation strategy. because of the fact that investment institution can take asset allocation strategy to change the risk of insolvency, which is caused by return guarantees, thereby, the cost of return guarantees is changed. this paper proposes a new approach combined with asset allocation strategy and return guarantee is set to a new form. we respectively calculate the value of multi-period return guarantees under constant-mix、deterministic lifestyle and constant proportion portfolio insurance strategies.5. This paper points out that investment institution can take asset allocation strategy to change the risk of insolvency, which is caused by return guarantees, thereby, the risk of return guarantees should be associated with asset allocation strategy, this paper proposes a new approach combined with asset allocation strategy ,through which we respectively obtain analytical solution of risk under constant-mix(CM) and constant proportion portfolio insurance (CPPI) strategies.finally,for return guarantees embedded in pension fund, the assumption that the interest rate is the constant is not realistic,because pension fund is a long term investment,and the strategy function of pension fund often is related with time. Therefore, this paper obtains analytical solution of risk under deterministic lifestyle strategies and stochastic interest rate model assumption. Main innovations of this paper:(1),This paper solves optimal investment problem for guaranteed equity-linked notes. the optimal investment strategy can be converted to the optimal investment strategy under return guarantees.Using stochastic optimal control method, this paper solve optimal investment problem. The research shows that the optimal investment strategy can make investment institutions pay investors according to contract, also can make investment institutions maximize the final wealth as much as possible.(2), This paper solve optimal investment problem under several new return guarantee form by introducing the idea of option. Different types of options are introduced according different financial product,for example: bull spreads are introduced to guaranteed equity-linked notes,and exchange options are introduced to pension fund.thereby, both the objective function and the optimal solution incorporate a new option item,which enrich the existing investment portfolio theory further.(3), Combined with the asset allocation strategy adopted by investment institution,this paper construct new theory model calculating the cost of return guarantees and the risk of return guarantees. The research shows the result calculated using the new method will reflect the cost and the risk more accurately.Draws a conclusion for all of points:Avail papers study optimal investment strategy for investment institutions only under a simple return low limit. However, there are a variety of new return guarantees. For example, return guarantee often limit investors’return within a fixed range,which exists both lower and upper return guarantees limit. Anther example: a more flexible return guarantees is set to minimum value of two function about benchmark. The change of return guarantees make it more complicate for studing the optimal investment strategy. this paper solve optimal investment problem under new return guarantees form by introducing the idea of option. The result shows that the optimal investment strategies include three parts: one is the speculative portfolio strategy, another is the hedge strategy for stochastic interest rate, the other is the hedge strategy for return guarantee. Different points between our conclusion and the existing literature lie that : Investment portfolio which are underlying asset of the option,can affect the price of the option,thereby, the first order derivative of option about underlying asset and interest rate appear in both the hedge strategy for return guarantee and the hedge strategy for stochastic interest rate.The investment strategy is adjusted dynamicly through option item in order to ensure that investment strategy is optimal. Through numerical analysis of the dynamic behavior of optimal strategies, the result shows that optimal wealth is always higher than return guarantee level, thus, the investment strategy can ensure that get the benefits guaranteed at least. Additionally, in the process of studing the cost and risk of return guarantees, we find that investment institution can take asset allocation strategy to change the risk of insolvency, which is caused by return guarantees, thereby, the cost and risk of return guarantees is changed. Thus, this paper proposes a new approach combined with asset allocation strategy.The results show that (1), The asset allocation strategy and strategy parameters used by investment institutions are important factors affecting the cost of return guarantees, there is obvious difference in cost caculated between constant-mix、deterministic lifestyle and constant proportion portfolio insurance strategies.The cost of return guarantee combined with asset allocation strategy will be more accurate; (2), the risk calculated can change with the risk preference of asset allocation strategy, which will reflect the risk more accurately.From a theoretical point of view, the study of this paper can enrich and improve portfolio theory, risk management theory and option pricing theory. From a practical point of view, the study of this paper can help investment institution to manage risk effectively and make investment decisions scientifically under return guarantee. This paper also can help regulatory agency to better guard against financial risk and improve the efficiency of regulation.