Shih Jennifer L. Wang and Rachel J. Huang
Abstract
This paper uses simulations to explore the effects of
incorrectly identifying the underlying interest rate process on assets, liabilities,
and surplus levels. We show that mismodeling the interest rate (called model risk) could not
only lead to a misstatement of the company's surplus, but could also cause a mismatch
between the company's assets and liabilities. Our simulations demonstrate that
three aspects of interest rates affect model risk: (i)
volatility, (ii) level of long-term interest rate, and (iii) the speed at which
the drift rate adjusts. We conclude that asset-liability managers should not ignore
the impact of the model risks, regardless of the length of their planning
horizon.
Key words and phrases: asset and liability management, immunization strategy, interest rate risk, model risk.
Corresponding Author:
Jennifer L. Wang
Department of Risk Management and Insurance
64, Sec. 2,
Taiwan R.O.C
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