Insurance

With a static hedging strategy, investors can only put at risk the excess wealth that remains after having secured all essential goals, which in general is relatively little, thus implying a limited access to the upside. The main benefit of insurance is that it allows investors to dynamically allocate to the well-diversified and risky performance-seeking portfolio more than the surplus available after having secured all essential goals. This is possible thanks to a commitment to reducing this risk-taking when / if the margin for error disappears. As such, insurance can be formally regarded as equivalent to dynamic hedging, which generates non-linear exposures to underlying sources of rewarded risk.