Article from - MEMBER | SOA · Actuarial Research Conference - Temple University August 2, 2013...
Transcript of Article from - MEMBER | SOA · Actuarial Research Conference - Temple University August 2, 2013...
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Article from:
ARCH 2014.1 Proceedings
July 31-August 3, 2013
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Calibration of a Regime-Switching Interest Rate Model
James Bridgeman Zepeng Xie Songchen Zhang Xuezhe ZhangUniversity of Connecticut
Actuarial Research Conference - Temple University
August 2, 2013
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Context for the Model
Long-Rate Anchor: 20 Yr, Not (yet) Whole CurveStress-testing
Not ForecastingNot Pricing
What�s Important:Severe but Plausible Extreme Scenarios
Plausible: in historical contextSevere: represent real stressesExtreme: on both (all) tails
Much Less Important:Accuracy Around the Likely Scenarios
Completely Irrelevant:Risk NeutralityArbitrage Free
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Summary
Typical Generators (e.g. AAA).....Gaussian-based volatility driverA single mean reversion point (MRP)
.....Fail To Produce Historically PlausibleRanges of Results
Unhistorical shape to the realized volatilityTightly bunched paths versus historical rangesMRP assumption largely drives the extreme paths
To Fix the ProblemsUse fat-tailed volatility driverRandomize MRP to spread range of extreme paths
But This Introduces More ParametersCalibration becomes a real challenge
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History of 20 Year US Treasury Rate
Plausible By De�nition
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20 Yr Treasuries: History vs AAA Generator Monthly %-iles
Neither Early 80�s Nor Japan Are Remotely Plausible In AAA
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No One Path Follows the Monthly Extremes
AAA Extreme Paths Are Not Japan-Like Near-Term - But They Persist
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Historical Frequency of 20 Year Rates
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Historical Frequency of 20 Year Rates vs AAA Generator
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Historical Realized Volatility of 20 Year Rates
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Historical Distr. of Realized Volatility of 20 Year Rates
High Kurtosis
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Historical Distr. of Realized Volatility vs AAA Generator
Stochastic Volatility Helps, May Not Fully Pick Up The Tails
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Historical Distr. of Realized Volatility vs AAA Generator
Missing Tails Are Signi�cant
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Comparative Statistics: History vs AAA
Rate Levels and Spread as well as the Shape of theRealized Volatility Di¤er Signi�cantly from History
60 Year AAA AAAHistory Mean StdDev
Rate = 20 Year TreasuryRate Mean .0635 .0410 .0081Rate StdDev .0266 .0117 .0058Rate Kurtosis (normal=3) 3.53 3.02 1.29Rate 6th-osis (normal=15) 21.5 17.7 26.1(6th Ctrl Mom/StdDev^6)Realized Volatility = ∆ lnRateVolatility StdDev .0360 .0338 .0039Volatility Kurtosis (normal=3) 10.9 5.3 1.6Volatility 6th-osis (normal=15) 479 76 124
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Consider A New Model
Traditional Models (including AAA)∆ lnRatet =F � (lnMRP � lnRatet�1) + SlopeAdjustment + (1� F ) � Gaussian∆
Proposed New Model:Regime-Switching with Random Regimes
∆ lnRatei =F � (lnMRPt � lnRatet�1)�DriftCompensation+ (1� F ) �DiWeibull∆whereMRPt = MRPt�1unlesst � tregime>a random Gamma(α, β) variate.In that case, the regime switches to a new, random MRP:MRPt =a random LogNormal variate, �xed until next regime-switch.And the regime-switching clock restarts at tregime = t.(a SlopeAdjustment can be included if desirable)
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What Is A DiWeibull?
DiWeibull Is Like Laplace:Laplace is symmetric Exponential, DiWeibull is symmetric Weibull
Very Heavy TailBridgeman Xie Zhang2 (Actuarial Research Conference - Temple University)Calibration August 2, 2013 15 / 34
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A Sample Path From the New Model (inti-MRP 4-53)
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New Model Requires 8 Parameters
2 Parameters For The Regime Clock Random Gamma(α, β) Variate.
α = 7.1 and β = 1.14 (in annualized units) follows from MLE appliedto historical random MRP estimates derived by Least Square Erroranalysis versus historical ratesAverage length of an interest rate regime is αβ = 8 Years plus 1 Month
1 Initial Value For The MRP
Least Square Error analysis versus historical rates gives
For 4-1953 start: init-MRP=2.36%For 6-2013 start: init-MRP=2.04%
This Leaves 5 Parameters To Be Determined
2 Parameters For The Lognormal Random MRP2 Parameters For The DiWeibull∆ Volatility Driver1 Mean Reversion Strength Factor (F in the formula)
Choose The 5 Parameters To Best Align Comparative Statistics vsHistory
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Comp. Stats: History vs New Model (init-MRP 4-53)
Rate Levels and Spread as well as the Shape of theRealized Volatility Now Align With History
60 Year Model ModelHistory Mean StdDev
Rate = 20 Year TreasuryRate Mean .0635 .0631 .0126Rate StdDev .0266 .0268 .0105Rate Kurtosis (normal=3) 3.53 2.96 1.24Rate 6th-osis (normal=15) 21.5 15.8 18.9(6th Ctrl Mom/StdDev^6)Realized Volatility = ∆ lnRateVolatility StdDev .0360 .0363 .0027Volatility Kurtosis (normal=3) 10.9 10.9 4.8Volatility 6th-osis (normal=15) 479 365 636
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New Model (init-MRP 4-53) vs History: Monthly %-iles
Only 55/723 Months Breach 5%-95%: History Fits Into This EasilyBridgeman Xie Zhang2 (Actuarial Research Conference - Temple University)Calibration August 2, 2013 19 / 34
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Hist Freq of 20 Yr Rates vs New Model (init-MRP 4-53)
Fits Like A Glove
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Realized Vol: History vs New Model (init-MRP 4-53)
Too Far In The Other Direction? At Least The Tail Is Good
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AAA Vs New Model (init-MRP 6-13): Monthly %-iles
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AAA Vs New Model (init-MRP 6-13): Rate Frequency
Same Prob. � 2.25%, Wild Di¤erence Thereafter
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An Extreme Path In The New Model (init-MRP 6-13)
For First 15 Years Slightly More Stress Than The 99%-ile AAA Scenario(And After 15 It Has Di¤erent Stresses That AAA Would Never Generate)
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Comp. Stats: New Model (init-MRP 6-13) vs AAA
Shape Of Model Realized Volatility Is Not OnlyFatter-Tailed On Average But Also Much More Varied
Model Model AAA AAAMean StdDev Mean StdDev
Rate = 20 Year TreasuryRate Mean .0628 .0126 .0410 .0081Rate StdDev .0271 .0104 .0117 .0058Rate Kurtosis (normal=3) 2.94 1.19 3.02 1.29Rate 6th-osis (normal=15) 15.3 17.7 17.7 26.1(6th Ctrl Mom/StdDev^6)Realized Volatility = ∆ lnRateVolatility StdDev .0364 .0027 .0338 .0039Volatility Kurtosis (normal=3) 10.8 5.0 5.3 1.6Volatility 6th-osis (normal=15) 368 706 76 124
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Realized Vol: New Model (init-MRP 6-13) vs AAA
Both Miss Parts of Historical Volatility Shape Despite Other Evidence
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Calibrate Instead On Direct Shape Statistics
Instead of Kurtotis and 6th-osis:Minimize L2 Distance of CDF to HistoryrZ(F (r)�H (r))2 dr
Minimize L1 Distance of CDF to HistoryZjF (r)�H (r)j dr
Use CDF Rather Than PDF To EmphasizeTailsUse Both Rates and Realized Volatility
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Calibration On L2 and L1 Distance, Means, Vol Std Dev
Model Model AAA AAAMean StdDev Mean StdDev
Rate = 20 Year TreasuryRate Mean .0631 .0078 .0410 .0081Rate StdDev .0190 .0048 .0117 .0058L2 Distance to History .0372 .0135 .0858 .0271L1 Distance to History .0102 .0035 .0230 .0070Realized Volatility = ∆ lnRateVolatility StdDev .0335 .0018 .0338 .0039L2 Distance to History .0067 .0012 .0074 .0030L1 Distance to History .0027 .0004 .0031 .0013
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Realized Vol. Comparison For This Alternative Calibration
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DiWeibull Driver For This Alternative Calibration
With This Calibration The Volatility Driver Has Milder TailBiModal Not A Problem: Mean-Reversion Smooths It Out In Realized Vol.
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Rate Distr. Comparison For This Alternative Calibration
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Monthly %-iles vs History For This Alternative Calibration
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And Compared To AAA Generator
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Extreme Path In This Alternative Calibration
Still Japan-like For A Good 15 Years
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