PROCEEDINGS May 15, 16, 17, 18, 2005 - Casualty Actuarial Society

180 MODELING FINANCIAL SCENARIOSThe economic series to be included in the model were interestrates, equity returns, inflation rates, unemployment rates, and realestate returns. An important consideration in this project is therecognition of the interdependencies between the various economicand financial series–for example, between interest ratesand inflation and between equity returns and interest rate movements.This paper provides a summary of the development of ascenario generation model, which is now available for publicuse. This work represents an initial step in the process ofhelping actuaries develop a better understanding of financialrisk. The complete project, available on the CAS Web Site(http://casact.org/research/econ/), includes a literature review, themodel, sample results, and a user’s guide.This paper is organized as follows. Section 2 reviews some ofthe key issues from the financial modeling literature, includingterm structure and equity return development. Previous actuarialmodels are also discussed. Section 3 describes the underlyingvariables of the model, illustrates how each process is simulated,discusses how the default parameters of the process were selected,and provides sources of data that are used to select theappropriate parameters. Section 4 briefly explains how to use thefinancial scenario model and discusses how to incorporate themodel into other actuarial applications. Section 5 illustrates theuse of the model, summarizes the output produced in one simulation,and includes a number of tabular and graphical displaysof the output. Section 6 provides a conclusion that encouragesactuaries to advance the work in this area.2. ISSUES AND LITERATURE REVIEWThere are many issues involved in building an integrated financialscenario model for actuarial use. This section reviewsthe literature in the modeling of the term structure and equity re-