Fallacies of Risk Control

Abstract

This paper demonstrates how risk control as applied to popular investment products can be based on a fallacy. In scope are option-based capital protected products and rules-based portfolio insurance products. In case of structured products risk control shifts the option’s volatility risk from the product provider to the end investor. The investor is presented a different product, for better or for worse, and not an improved version of the “base” product. Adding risk control to the risky asset of portfolio insurance leaves the portfolio allocation unchanged if, for good reasons, market exposure is already inversely linked to volatility. The investor receives nothing else but the “base” product, be it in a commercially more appealing presentation.