Research area: quantitative finance
Department: ORTEC Centre for Financial Research (OCFR)
Supervisor: dr. Hens Steehouwer
Description: Vector AutoRegressive (VAR) models are often used for simulating scenarios of financial and economic variables that are important in determining the risk and return profile of pension funds and insurance companies. By combining these models with a so called pricing kernel, also sometimes called deflator, these scenarios can also be used for valuation purposes. “Another” class of models that is especially designed for valuation purposes are the risk neutral or arbitrage free models. An advantage of the VAR / pricing kernel approach is that there is an automatic consistency between on the one hand the scenarios from the VAR model that are used to calculate classical (ALM) risk and return numbers and, on the other hand, the valuation results that are obtained by applying the pricing kernel on the same problem. The first objective of this project is to go through the process of constructing a pricing kernel corresponding to a realistic VAR model in a very practical way and to make an inventory of all the issues that are encountered. A second objective could be to see how the pricing kernel approach could be applied to a Frequency domain Dynamic Factor model (FDFM), which can be seen as an extension of a conventional VAR model. As a final result, pricing kernel scenarios could be applied on a real world (pension fund) valuation problem and the results can be compare to those of a risk neutral approach.
Background information:
Hoevenaars, R.P.M.M. and E.H.M Ponds (2007), “Valuation of intergenerational transfers in funded collective pension schemes”, Working Paper, Maastricht University.
(www.unimaas.nl/media/um-layout/fdewb/opmaak.htm?http://www.fdewb.unimaas.nl/KE/members/member_pagina%20hoevenaars.htm)
Steehouwer H. (2005), “Macroeconomic Scenarios and Reality. A Frequency Domain Approach for Analyzing Historical Time Series and Generating Scenarios for the Future”, PhD thesis, Free University of Amsterdam.