AFIR Graf Kling Russ
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8/13/2019 AFIR Graf Kling Russ
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Financial Planning and Risk-return ProfilesStefan Graf, Alexander Kling, Jochen Ru
Stefan Graf AFIR ColloquiaMadrid | June 2011
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Financial Planning and Risk-Return Profiles Stefan Graf, Alexander Kling, Jochen RuPage 2
Agenda
Motivation
Assessing products risk-return profiles existing methodologies
Risk-return profiles by means of stochastic modeling
Conclusion
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Financial Planning and Risk-Return Profiles Stefan Graf, Alexander Kling, Jochen RuPage 3
Motivation
Government-run pay-as-you-go systems suffer from demographic
changes
demand for private old age provision increases
How to choose optimal products?
Vast body of literature on determining optimal (often dynamic) asset
allocations mostly using expected utility approaches
Really practicable for typical client?
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Financial Planning and Risk-Return Profiles Stefan Graf, Alexander Kling, Jochen RuPage 4
Motivation
Contribution
Introduce methodology on how to derive risk-return profiles and compare
them to existing approaches
Quantitative analyses of common products with and without investment
guarantees
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Financial Planning and Risk-Return Profiles Stefan Graf, Alexander Kling, Jochen RuPage 5
Products under consideration
Products without embedded guarantees
Investment in equity and balanced fund
Products with money back guarantee
Static option-based product (underlying + put)
(Dynamic) CPPI strategy on a client individual basis (iCPPI)
Products with savings premium guarantee
(Dynamic) CPPI strategy implemented in a mutual fund and thus
managed on a collective basis (CPPI high watermark fund)
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Financial Planning and Risk-Return Profiles Stefan Graf, Alexander Kling, Jochen RuPage 6
Agenda
Motivation
Assessing products risk-return profiles existing methodologies
Risk-return profiles by means of stochastic modelling
Conclusion
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Financial Planning and Risk-Return Profiles Stefan Graf, Alexander Kling, Jochen RuPage 7
Assessing the risk-return profile
Sample illustration
Underlying investment vehicle is projected assuming some (constant)
deterministic performance
Products maturity benefit is then calculated accordingly
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Financial Planning and Risk-Return Profiles Stefan Graf, Alexander Kling, Jochen RuPage 8
Assessing the risk-return profile
Sample illustration *, e.g. equity fund vs. CPPI high watermark fund
*12 year-single premium investment
Equity Fund
0
50,000
100,000
150,000
200,000
250,000
0% 3% 6% 9%
CPPI high watermark fund
0
50,000
100,000
150,000
200,000
250,000
0% 3% 6% 9%
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Financial Planning and Risk-Return Profiles Stefan Graf, Alexander Kling, Jochen RuPage 9
Assessing the risk-return profile
Sample illustration - pitfalls
Asset allocation neglected
Lack of volatility conceals path-dependant effects
e.g. reallocation of risky and riskless assets in CPPI products
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Financial Planning and Risk-Return Profiles Stefan Graf, Alexander Kling, Jochen RuPage 10
Assessing the risk-return profile
Backtesting
Underlying investment vehicle is projected assuming it had been invested
in the past (according to some time series)
Products maturity benefit is then calculated accordingly
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Financial Planning and Risk-Return Profiles Stefan Graf, Alexander Kling, Jochen RuPage 11
Assessing the risk-return profile
Backtesting *, e.g. equity fund vs. CPPI high watermark fund
*Single premium investment in MSCI World and German Government Bonds from 1998-2009
Equity Fund
0
50,000
100,000
150,000
200,000
250,000
Equity exposure
CPPI high watermark fund
0
50,000
100,000
150,000
200,000
250,000
Bond exposure Equity exposure
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Financial Planning and Risk-Return Profiles Stefan Graf, Alexander Kling, Jochen RuPage 13
Agenda
Motivation
Assessing products risk-return profiles existing methodologies
Risk-return profiles by means of stochastic modeling
Conclusion
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Financial Planning and Risk-Return Profiles Stefan Graf, Alexander Kling, Jochen RuPage 14
Risk-return profiles
Stochastic modeling of
Equity (modified (Heston, 1993))
Interest rates (Cox et al., 1985)
Derive maturity benefit by
Generating equity and interest rate scenarios
Modeling fund management decisions
Modeling products investing in various funds
Assess products risk-return profile by estimating the probability
distribution of maturity benefits
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Financial Planning and Risk-Return Profiles Stefan Graf, Alexander Kling, Jochen RuPage 15
Risk-return profiles
Quantitative results
Single premium Regular premium
Internal rate of return
-5.00%
-3.00%
-1.00%
1.00%
3.00%
5.00%
7.00%
9.00%
11.00%
13.00%
15.00%
EquityFund
iCPP I O ption BasedProduct
BalancedFund
CPPIhigh watermark
fund
50% 90% Median Expected return Sample Illustration
Internal rate of return
-5.00%
-3.00%
-1.00%
1.00%
3.00%
5.00%
7.00%
9.00%
11.00%
13.00%
15.00%
EquityFund
iCPPI Opt ion BasedProduct
BalancedFund
CPPIhigh watermark
fund
50% 90% Median Expected return Sample Illustration
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Financial Planning and Risk-Return Profiles Stefan Graf, Alexander Kling, Jochen RuPage 16
Agenda
Motivation
Assessing products risk-return profiles existing methodologies
Risk-return profiles by means of stochastic modelling
Conclusion
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Financial Planning and Risk-Return Profiles Stefan Graf, Alexander Kling, Jochen RuPage 17
Conclusion and further research
Conclusion
Existing approaches provide insufficient information and may lead to
misselling
Introduced methodology provides appropriate assessment of products
risk-return profile
Further research
Extension to retirement phase products?
Model risk?
e.g. modeling of inflation,
How to communicate the information appropriately (to financial advisors
and clients)?
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Financial Planning and Risk-Return Profiles Stefan Graf, Alexander Kling, Jochen RuPage 18
Thanks for your attention
Contact details
Stefan Graf [email protected]
Alexander Kling [email protected]
Jochen Ru [email protected]
mailto:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]