Issues with the Smith-Wilson method

DOI10.1016/J.INSMATHECO.2016.08.009MaRDI QIDQ2374100zbMATH OpenOpenAlexFDO

Authors M. Lindholm, Andreas Nordvall Lagerås

Publication date 14 December 2016

Published in Insurance Mathematics \& Economics (Search for Journal in Brave)

Full work available at URL https://arxiv.org/abs/1602.02011

zbMATH Keywords

discount curveextrapolationhedginginterpolationSmith-WilsonSolvency IItotally positive matrixyield curve

Mathematics Subject Classification ID

Gaussian processes (60G15) Interest rates, asset pricing, etc. (stochastic models) (91G30) Actuarial science and mathematical finance (91G99)

Abstract: The objective of the present paper is to analyse various features of the Smith-Wilson method used for discounting under the EU regulation Solvency II, with special attention to hedging. In particular, we show that all key rate duration hedges of liabilities beyond the Last Liquid Point will be peculiar. Moreover, we show that there is a connection between the occurrence of negative discount factors and singularities in the convergence criterion used to calibrate the model. The main tool used for analysing hedges is a novel stochastic representation of the Smith-Wilson method. Further, we provide necessary conditions needed in order to construct similar, but hedgeable, discount curves.

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Cites work

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Cited in

(2)

• Construct Smith-Wilson risk-free interest rate curves with endogenous and positive ultimate forward rates
• Stripping the Swiss discount curve using kernel ridge regression

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