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

MODELING FINANCIAL SCENARIOS 207model allows users to specify scenarios for three economic variablesin the model; nominal interest rates, inflation, and equityreturns. For example, with respect to nominal interest rates, eachof the “New York 7” 7 regulatory interest rate tests are preprogrammedinto the model and may be selected by the user; theuser may also specify a scenario of her or his own creation forany of the three economic processes.Employing the Financial Scenario ModelIt is expected that the financial scenario model will be implementedin a variety of different analyses. The model can be usedas the underlying engine for creating many financial scenariosand can be tailored for a user’s specific purposes. For example,Ahlgrim and D’Arcy [1] use the model as the underlying assetreturn generator to assess the risk inherent in pension obligationbonds issued by the state of Illinois. In this case, the model wasextended to include international equities and to compute yieldson coupon bonds from the nominal interest rates.5. ILLUSTRATIVE SIMULATION RESULTSRegardless of the mathematical sophistication of the variablesincorporated in a model, the accuracy of the procedures used todetermine the parameters, and the timeliness of the values onwhich the calibration is based, the most important test of the validityof any model is the reasonability of the results. This sectionwill examine the results of a representative run of the financialscenario model and compare the output with historical values. Itshould be reiterated that the goal of choosing the parameters forthe model was not to replicate history. Correspondingly, we donot include measures of fit when comparing the sample results7 The “New York 7” are seven different interest rate scenarios originally specified by NYRegulation 126 for use in asset adequacy testing and actuarial opinions for life insurers.Each scenario is based on deviations from the current term structure.