Posted: 3 May 1998
Date Written: April 1996
It is common to find index funds being marketed with a protective floor. It gives investors the upside potential of the equity market, while protecting them from possible losses. In this paper, we describe a new type of protective floor, in which the floor level is not set at inception of the contract. Instead, during the contract life, the holder can give notice --- he shouts --- to set the floor at the prevailing index level. It is shown in the paper, that the optimal shout policy does not depend on the index level, but only on time-to-maturity. The concept is generalized further to multiple-shout floors. If the index hits a higher level after the first shout, the holder is allowed to shout again to reset the floor at the then prevailing (higher) index level. An efficient numerical model is proposed to price the multiple-shout floors.
JEL Classification: G13
Suggested Citation: Suggested Citation