Don't you think a CPPI should be splitted into a zero coupon + an option? By doing so, don't you think you have a big interest rate risk in this investment? My traders are arguing a lot with me saying there's no interest rate risk... I don't think so! It might not be the biggest risk, but it's there. It's a zero coupon, and if it's not hedged/funded in the right way it generates a huge interest rate VaR. I'm just addressing the IR risk in the zero coupon component...Can someone express their view about this?Thanks

QuoteOriginally posted by: diffusion2000Don't you think a CPPI should be splitted into a zero coupon + an option? By doing so, don't you think you have a big interest rate risk in this investment? My traders are arguing a lot with me saying there's no interest rate risk... I don't think so! It might not be the biggest risk, but it's there. It's a zero coupon, and if it's not hedged/funded in the right way it generates a huge interest rate VaR. I'm just addressing the IR risk in the zero coupon component...Can someone express their view about this?ThanksActually, the whole point of CPPI is that it's NOT a zero plus an option. Essentially CPPI generates a mis-hedged strategy for generating returns on a risky asset. It's a really bad short gamma strategy - hence "the gap risk"In contrast in a normal option, you allocate money between cash and asset - often starting off with only a 50% allocation to the risky asset, increasing it as the risky asset performs better, deleveraging as it gets worse. The vision of BS was that you could give a mathematical scheme to this allocation strategy (delta hedging) and under some assumptions, no matter what path the underlying took you came up with the same hedging costs. This gave you the option premium.CPPI in contrast starts off with allocating almost 100% to the risky asset (hence why I call it "mis hedged"), but if the risky asset gets too low compared to the Zero you track u kill the entire attempt to replicate a good performance. Hence the "gap risk"So the BS delta hedging recipe is a precise asset allocation strategy, while CPPI allocation tables are dreamt up by the structurer who writes up the particular CPPI. So it's still short gamma, but not very well optimised - which is why the "gap risk" comes in. I dont think your average Jope Bloggs really gets it though.NA.