Browsing by Subject "Model risk"

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  • Ronkainen, Vesa; Koskinen, Lasse; Koskela, Laura (2008)
    In the EU the supervision of the insurance industry is expected to step into the new Solvency II framework within some years. The new framework will mean a fundamental update for both valuation and solvency requirements. Instead of just offering a standard formula for calculating the solvency capital requirement, in Solvency II insurance companies will be encouraged to develop internal models that are expected to be able to assess numerous effects which would not be easily quantified using the “one fits all” standard approach. However, to develop an internal model that will satisfy the approval criteria is a major project, during which the model builders and implementers will be faced with serious challenges.
  • Kaliva, Kasimir; Koskinen, Lasse; Ronkainen, Vesa (2007)
    There is a major trend in the insurance sector towards arbitrage-free valuation of insurance liabilities and assets. The assumption of no-arbitrage is fundamental in financial modelling. This paper surveys assumptions of arbitragefree modelling and studies their consequences for the use of internal model in insurance. The model uncertainty arises as a particularly severe problem under the assumption that the conditions of arbitrage-free complete market theory do not hold and all participants in the market are not fully rational. We argue that the approximation errors of these idealistic assumptions are generally larger in insurance applications than elsewhere in the financial sector. Hence, the model uncertainty plays a particularly important role in the use of internal models. This should be taken into account in the development of the models and in risk management practice. Finally, we present some known Bayesian methods that might be useful for managing the model risk.