Actuarial Financial Scenario Generator Project Sponsored by the Casualty Actuarial Society and the Society of Actuaries

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Actuarial Financial Scenario Generator Project
Sponsored by the Casualty Actuarial Society and
the Society of Actuaries

• Kevin Ahlgrim, ASA, Bradley University
• Stephen DArcy, FCAS, University of Illinois
• Richard Gorvett, FCAS, Zurich North America
• Presented at Victoria University
• Wellington, New Zealand
• February 2003

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Overview of Project

• CAS/SOA Request for Proposals on
• Economic Scenario Generators for Dynamic
  Financial Analysis and Cash Flow Testing
• Goal is to provide actuaries a model for
  projecting economic and financial indices with
  realistic interdependencies among the variables.

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Scope of Project

• Literature review
• Develop economic (financial) scenario generator
  model
• Generate scenarios over 50 year time horizon
• Document and facilitate use of model

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Components of Model

• Inflation
• Real interest rates
• Nominal interest rates
• Equity returns
• Large stocks
• Small stocks
• Equity dividend yields
• Real estate returns
• Unemployment

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Inflation

• One factor mean reverting process
• Speed of reversion .4
• Mean reversion level 4.8

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Real Interest Rates

• Two factor Vasicek term structure model
• Short term rate and long term mean are both
  stochastic variables

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Nominal Interest Rates

• Combines inflation and real interest rates
• i (1q)x(1r)-1
• i nominal interest rate
• q inflation
• r real interest rate

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Equity Returns

• Excess equity returns (over the nominal interest
  rate)
• Empirical fat tails issue
• Regime switching model
• Low volatility regime
• High volatility regime

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Unemployment

• Phillips curve
• Inverse relationship between unemployment and
  inflation
• First order autoregressive process

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Results

• Funnel of doubt plots
• Histograms of Actual Values vs. Model Values
• Inflation
• Nominal interest rates
• 3 month
• 1 year
• 10 year
• Equity returns
• Large stocks
• Small stocks
• Unemployment rate

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