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

232 MODELING FINANCIAL SCENARIOSTABLE 3Historical Correlations (April 1953—December 2001)Large Small 3-Month 1-Year 10-Year InflationStocks Stocks T-Bills Treasuries Treasuries RateLarge Stocks 1.000Small Stocks 0.744 1.0003-Month T-Bills ¡0:078 ¡0:065 1.0001-Year Treasuries ¡0:074 ¡0:066 0.991 1.00010-Year Treasuries ¡0:030 ¡0:025 0.912 0.942 1.000Inflation Rate ¡0:138 ¡0:100 0.593 0.576 0.478 1.000the one-year nominal interest rate, and 0.617 between the 10-yearinflation rate and the 10-year nominal interest rate. Since nominalinterest is the sum of the real interest rate and the inflation rate,and the real interest rate is constrained to be no less than thenegative of the inflation rate, this correlation is built into themodel.Historically, T-bill rates and stock returns have been negativelycorrelated (¡0:078 for large stocks and ¡0:065 for smallstocks). In the model, there was a slight positive correlation betweenthe one-year nominal interest rate and stock returns (0.099for large stocks and 0.087 for small stocks). Also, the historicalcorrelation between inflation and stock returns has been negative(¡0:138 for large stocks and ¡0:100 for small stocks). Thecorrelations in the model values between the one-year inflationrate and large stocks and small stocks were 0.089 and 0.076,respectively.Alternate ParametersThe base parameters provide one feasible set of values to usein modeling future economic conditions. These should be viewedas a starting point in these applications. However, users shoulddevelop an understanding of the impact of the different param-