With the concept of a shifted log normal model calibration of the interest rate

With the concept of a shifted log normal model

This preview shows page 54 - 56 out of 66 pages.

With the concept of a shifted log-normal model calibration of the interest rate risk shocks can be performed resulting in curves that show realistic forms and take into account both absolute and relative components in shock. This reflects the elasticity of the interest rate risk which is dependant also upon the currently observed absolute level of interest rates (e.g. negative rates might change to a more negative rate but with less absolute amplitude as would rates that are positive with several 100 BP). Stress calibration However, stress calibration tends to become difficult beyond the last liquid point. Here, even for the derivation of best estimate curves methodology relies on extrapolation making use of an UFR. For the UFR, current discussion tends to limit yearly changes to the revised UFR methodology to a fixed number of basis points annually (between 10 and 20 BP). The limitation of volatility reflects the steadiness of the long-term UFR Template comments 54/66
Image of page 54

Subscribe to view the full document.

Comments Template on Discussion Paper on the review of specific items in the Solvency II Delegated Regulation Deadline 3 March 2017 23:59 CET but takes into account at the same time long term trends in interest rates also. For the interest rate risk established technology and methodology allow for a dual method as follows perfectly in line with current UFR discussion and the best estimate curve methodology: 1) Use shifted log-normal model to calibrate interest rate risk in liquid zone of the curve. 2) Use similar extrapolation technique like in best estimate case starting on level of newly calibrated stressed curve from LLP and extrapolate towards shifted UFR under stress shifted by maximum annual change rate of UFR (10 – 20 BP). 3) Perform step 2 for both interest rate down and interest rate up shock With this methodology the calibration already takes into account the change in UFR so that no additional stress will have to be considered within the standard formula. Also, the concept reflects the construction of the best estimate curve and thus makes use of already set standards. Description of the shifted log-normal model: Here, the log-returns of shifted spot rates are modelled via a normal distribution. We briefly sketch how the model can be set up for any individual spot rate tenor (without including the PCA approach, noting that this can be transferred to a PCA setup similarly): Approach: 1. Starting point is historic time series data used for the calibration for spot rate with tenor n, i.e. {r n (t 1 ),…, r n (t k )} where r n (t i ) refers to the value of the n-year spot rate at time t i 2. Shift all historic time series data for the spot rate with tenor n under consideration used for the calibration by the shift parameter δ, i.e. consider {r n (t 1 )+ δ,…, r n (t k ) + δ } as input for the calibration.
Image of page 55
Image of page 56
  • Winter '14

What students are saying

  • Left Quote Icon

    As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

    Student Picture

    Kiran Temple University Fox School of Business ‘17, Course Hero Intern

  • Left Quote Icon

    I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern

Ask Expert Tutors You can ask 0 bonus questions You can ask 0 questions (0 expire soon) You can ask 0 questions (will expire )
Answers in as fast as 15 minutes