Portfolio insurance designed to limit losses can amplify market volatility.

Evidence

Take portfolio insurance, in which investors use “stock index futures contracts to offset positions in the stock market to limit their losses to a predetermined proportion of their original investment… It is one of the ironies of this complex computerized age … that an approach designed to insure against more losses than they are willing to accept is seen by some as contributing to the very volatility that makes the markets so treacherous for so many investors. — Shapiro, Susan P., The Social Control of Impersonal Trust, 144

Categorization

• CANDY: A neat elevator fact: the strategy that hedges investors’ downside risk is accused of making the market more treacherous for everyone.
• XREF: Connects to the tragedy-of-commons pattern where individually rational hedges create collective instability (e.g. circuit breakers, bank runs). — connects to: Compressed decision time makes financial markets prone to cascading collapse — David Harvey, The Condition of Postmodernity: An…, 1938; Derivatives inverted from insurance into engines that increase volatility exposure. — Aris Komporozos-Athanasiou, Speculative Communities: Living with…, 91; The log-normal assumption may have been self-undermining through portfolio insurance. — Donald MacKenzie & Yuval Millo, Constructing a Market, Performing Theory, 191 (+16 more)

Related

• Arbitrage linking futures prices to the index enabled portfolio insurance via cheap futures trading. (similarity 0.85)
• Widely adopted portfolio insurance would amplify market price movements (similarity 0.84)
• Portfolio insurance creators accepted increased volatility as unproblematic (similarity 0.84)
• Portfolio insurance is structurally equivalent to buying a put option on the portfolio. (similarity 0.82)
• Portfolio insurance forced clients to miss the entire market rebound after the crash (similarity 0.82)
• Derivatives inverted from insurance into engines that increase volatility exposure. (similarity 0.82)
• The 1982 S&P 500 futures launch transformed how portfolio insurance could be implemented. (similarity 0.82)
• Portfolio insurance’s real risk was internal self-impact, not external shocks. (similarity 0.81)
• The log-normal assumption may have been self-undermining through portfolio insurance. (similarity 0.81)
• Portfolio insurance sells more stock as price falls, creating mechanical downward supply. (similarity 0.81)
• Portfolio insurance collapsed after 1987 partly because it became socially tainted (similarity 0.80)
• Index options markets now function like catastrophe insurance markets with concentrated writers (similarity 0.80)
• Portfolio insurers could publish their full contingent trading schedule in advance. (similarity 0.79)
• Portfolio insurance’s inventors concede it helped cause the 1987 crash (similarity 0.79)
• Portfolio insurance trades could double NYSE volume on a 3 percent drop (similarity 0.79)