Preprint Article Version 1 NOT YET PEER-REVIEWED

Solvency II Calibrations: Where Curiosity Meets Spuriosity

  1. Chair of Financial Econometrics, Department of Statistics, and Center for Quantitative Risk Analysis, Ludwig–Maximilians–Universität München, Akademiestrasse 1/I, 80799 Munich, Germany
Version 1 : Received: 11 July 2016 / Approved: 12 July 2016 / Online: 12 July 2016 (09:38:23 CEST)

How to cite: Mittnik, S. Solvency II Calibrations: Where Curiosity Meets Spuriosity. Preprints 2016, 2016070021 (doi: 10.20944/preprints201607.0021.v1). Mittnik, S. Solvency II Calibrations: Where Curiosity Meets Spuriosity. Preprints 2016, 2016070021 (doi: 10.20944/preprints201607.0021.v1).

Abstract

The Solvency II regulatory framework specifies procedures and parameters for determining solvency capital requirements (SCRs) for insurance companies. The proposed standard SCR calculations involve two steps. The Value–at–Risk (VaR) of each risk driver is measured and, in a second step, all components are aggregated to the company’s overall SCR, using the Standard Formula. This formula has two inputs: the VaRs of the individual risk drivers and their correlations. The appropriate calibration of these input parameters has been the purpose of various Quantitative Impact Studies that have been conducted during recent years. This paper demonstrates that the parameter calibration for the equity–risk module—overall, with about 25%, the most significant risk component—is seriously flawed, giving rise to spurious and highly erratic parameter values. As a consequence, an implementation of the Standard Formula with the currently proposed calibration settings for equity–risk is likely to produce inaccurate, biased and, over time, highly erratic capital requirements.

Subject Areas

Solvency capital requirements capital, standard formula, near unit root, spurious correlation, VaR—implied correlations, tail dependence

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