CHP 18: Modelling

Question 1

Factors to consider when finding a model (New, existing/purchased)

Answer 1

Flexibility: Desired flexibility of the model
Accuracy: Required accuracy level
Cost of each option
Expertise: In-house expertise available

Usage: Number times the model will be used
Purpose: Ensuring the selected model is fit for the purpose

Question 2

Requirements of a good model (CLERICAL ADVISORS)

Answer 2

Capable of refinement
Length/expense of run not too long/high
Easy to understand
Rigorous
Independent verification of outputs
Clear results
Adequately documented
Large range of implementation methods

All significant features allowed for
Developable
Valid
Inputs to parameter values appropriate
Sensible joint behaviour of variables
Output and workings are communicable
Reflects risk profile
Simple whilst retaining key features

Question 3

How to determine a deterministic model

Answer 3

1. Specify the purpose
2. Collect data, group and modify it
3. Choose the form of the model
4. Identify parameters and variables
5. Ascribe values to those parameters
6. Construct a model based on expected cashflows
7. Check goodness of fit against past data, modify fit if poor
8. Run the chosen model using selected values of variables
9. Run using estimates of future values of variables
10. Sensitivity test using different parameters

Question 4

How to determine a stochastic model

Answer 4

1. Specify the purpose
2. Collect data, group and modify it
3. Choose a distribution for each stochastic variable with parameter values
4. Specify correlation between variables
5. Construct a model based on expected cashflows
6. Check goodness of fit against past data, modify fit if poor
7. Run it many times using a random sample from the chosen distribution
8. Produce a summary of results showing the distribution of the modelled results.