Modelling Flashcards
What is a model?
*small representation of reality
*designed to show NB features of reality
Model sources
*New
*Modify existing model
*external commercial purchase
How to decide on model
FACEUP
F: flexibility required
A: accuracy required
C: cost
E: expertise in house
U: use of model
P: fit for purpose
Dynamic model
Allows for interaction between various features under different circumstances
Deterministic model
SEER
S: clarity on scenarios tested
E: Easy and quick to design, build and run
E: easy to explain results
R: requires thought as to range of economic scenarios to run
Stochastic models
COUS
C: allow for CORRELATION between variables
O: good at assessing OPTIONS and GUARANTEES
U: better at showing UNCERTAINTY of results
S: test a wide range of SCENARIOS
Process of modelling
- Specify purpose of model
- Collect, group, modify data
- Choose model form
3s1 - choose suitable density function for each stochastic variable
3s2 - specify correlations between variables
3d1 - identify parameters and variables
3d2 - ascribe parameter values - Construct model based on expected cashflow
- Check goodness of fit
6 . If GoF fails fit new model
6d1 - Run model using selected values
6d2 - sensitivity test parameters
6s1 - run model repeatedly using random generated values of stochastic variables
6s2 - produce summary of results
Specify purpose of model
- Set overall time horizon
*future period of protections - Set time for output of cashflows
*frequent - reliable output
* too frequent- spurious accuracy
Model point(s)
*representative single policy representing a homogeneous group of policies
*capture most important characteristics of the group
* output scaled up to get numbers for whole group
*chosen to reflect expected profile of future business
Discount rate
- Allows for
* required return
*statistical risk attaching to the cashfows
-model, parameter and random fluctuation risk
- assessed analytically (sensitivity analysis, stochastic model, comparison with market data)
Discount rate theory vs practice
Theory: diff discount rate for each component of net cashflow
Reality: single rate, simple, reflects average level of risks
Premiums
- Model points
- Risk discount rate
- Marketability of premiums
* design
*features
*sales channel
* profit criterion
*size of market
*decision to market contract - Options and Guarantees
*stochastic model - Capital requirements
6.busin3ss objectives
Good model
TERRIFIC DRIP
T: time period between projected cashflows
E: consisted with general economic principles
R: reflect risk profile
R: run must not be long, complex, expensive with hard to interpret results
I: implementable in a range of ways
F: include significant FEATURES
I: input parameters and values must be appropriate
C: communicable and independent verifiable output
D: valid, rigorous and well DOCUMENTED
R: refinement and development
I: interactions must be sensible
P: parsimonious
