Research area: quantitative finance
Department: Insurance Advisory
Supervisor: dr. David van Bragt
Description: Risk-neutral models play a crucial role in the valuation of contingent claims like embedded options in insurance liabilities and pension deals. At ORTEC Finance we have developed and implemented a consistent risk-neutral scenario model for nominal interest rates, inflations, real interest rates, stock returns and exchange rates. This model is based on various extensions of a combination of a two-factor Hull-White interest-rate model and the well-known Black-Scholes stock price model. This model is especially used for Monte Carlo valuations of complex (embedded) option constructions and is complemented by optimization tools to calibrate the parameters of the model on market prices of selected financial instruments (swaptions, stock options, etc.). To get a more complete match with the investment portfolios we encounter in practice, the model needs to be extended with a model for the valuation of asset classes that contain significant credit risk. The specific objectives of this project are to investigate how the existing risk-neutral simulation model can be extended consistently with credit risk. Another question is how the credit part of the model can be calibrated on market prices of credit derivatives.
Background information:
Van Bragt, D. and H. Steehouwer (2007), “Recent Trends in Asset and Liability Modeling for Life Insurers”, OCFR Methodological Paper No. 2007-01.