Optimal Investment in Structured Bonds

Abstract

Structured investment vehicles for retail customers have become increasingly prevalent, and also increasingly complex. Yet numerous articles have shown that many popular structures offer rather poor performance for the buyer, relative to the expected payoff and to the cost of producing that payoff with a combination of simpler derivative contracts. Retail investors seem to like payoffs resembling that of a protectiveput strategy very much, with exposure on the upside but limited risk of loss on the downside. Why should they be willing to pay more for such products than they are worth? In this article, Jessen and Jørgensen show that such structured products can make sense for an investor with an ordinary utility function if the diversification value of exposure to the underlying index is great enough and the structured product is the only way they can obtain exposure to that index.

TOPICS: Derivatives, mutual funds/passive investing/indexing, portfolio theory