This thesis models the theoretical relationship between portfolio insurance strategy and the stock market volatility. This model is designed to capture the essential features of interactions between two markets in the presence of trading for the purpose of portfolio insurance. When the stock index futures contract is traded, investors can employ portfolio insurance strategies using it. These strategies basically require buying futures contracts at times of increasing spot price and selling futures contracts at decreasing spot price. These strategies cause additional price changes in futures market. These futures price changes are transmitted to spot market due to arbitrage trading activities between these two markets. Simulation method is employed to examine quantitative effects. It sheds additional light on the relationship between the stock market volatility and economic variables that affect price determination in both markets.
