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30 Cards in this Set
- Front
- Back
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What are the major differences in the 1st and 2nd evolutionary step inDecision Analysis? |
• Use of Distributions for the inputs instead offixed amounts • Output is also a Distribution |
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What is the major difference between the 2nd and 3rd evolutionary step inDecision Analysis? |
Use a Risk Preference (Utility) function to valuethe possible outcomes |
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What is the argument that the 3rd evolutionary step in Decision Analysis isUnnecessary |
Firms only compensate owners for systemic risk,since the firm-specific risk is averaged out. Therefore the company risk preference is irrelevant |
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Name some reasons why companies should pay attention to firm-specific risk |
1. Management cannot easily separate firm-specificvs. systemic risk 2. Some risks are instantaneous, and can’t bemanaged through discounting 3. market based information is too noisy to use forcost-benefit analysis |
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Owners and Management want corporate policy that makes risk management decisions more: (4)
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• Objective• Consistent• Repeatable• Transparent |
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Spetzler parameterizes a Utility function for management.What are the benefits of using a Utility function to make decisons? (3) |
• Transparent• Objective• Mathematical |
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Walls identifies an efficient set of portfolios for the firm to invest in.Why is this not sufficient to select the best portfolio |
We need the company risk preference to select the optimal portfolio along the efficient frontier |
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According to Mango what 3 questions does Walls ask? |
1. How much risk are we willing to tolerate 2. How much reward are we willing to give up for a given reduction in risk 3. Are the risk-reward tradeoffs along the efficient frontieracceptable to us? The first two come from the parameterized utility functionIt’s possible there are no options on the efficient frontier thatare acceptable |
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Why is allocating capital considered irrelevant? (2) |
1. All of the company’s capital supports each policy 2. Allocating cost of capital is preferred |
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What risk sources should capital be allocated to? (2) |
1. Risk taking sources (eg. products) 2. Non Risk taking sources (eg. credit risk) |
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What is RORAC? and how do you calculate it? (2 steps) |
Return On Risk Adjusted Capital 1. Allocate Capital on a risk adjusted basis 2. Apply a company wide hurdle rate to determinethe cost of capital in $ 3. This is a form of cost of capital |
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How do Merton & Perold define the cost of capital? |
Amount to purchase a guarantee that the firm will meet its obligations |
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How do we use Cost of Capital to determine if a course of action is suitable |
EVA = NPV − [Cost of Capital] > 0 Economic Value Added |
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Under Capital Allocation, how do we determine if a course of action issuitable,for example a purchase of additional reinsurance |
NPV > Cost of Capital [Net Reinsurance Cost] < −∆ Capital · [Hurdle Rate] That is the benefit to cost of capital should be greater thanthe reinsurance cost Reinsurance Premium 30m Expected Reinsurance Benefit 20m Net Reinsurance Cost 10m ∆ Capital -100mHurdle Rate 12% 10m < 12m Cost < Benefit |
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What is Value at Risk VaRα? |
The loss at the αth percentile. VaRα = E [Y|F(Y) ] = α |
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What is Tail Value at Risk TVaRα? |
The average loss excess of the percentile αTVaRα = E [Y |F(Y) > α] |
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What is Excess Tail Value at Risk XTVaRα? |
Conceptually, the expected losses are funded by premium.The excess is funded by capital - This is what XTVaRrepresents.XTVaRα = EYF(Y) > α− EY TVaR - Mean |
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What is Expected Policyholder Deficit EPD? |
If capital is set as VaRα then EPD is the expected loss given default, times the probability of default. EPD = (TVaRα − VaRα) · (1 − α) |
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Why shouldn’t we use a 1-in-3000 year risk metric? (3) |
• Not able to accurately measure the losses so deep in the tail • Selection of 1-in-3000 is arbitrary • Better to choose probability levels that are less remote, but still impact the company |
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Why does Venter not recommend VaR as a risk measure for insurance companies? |
It is to simplistic for insurers, which tend to use a number of risk measures, many of which are more informative than VaR |
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What is the Value of the Default Put Option? |
The market cost of purchasing insurance to cover any losses,when in default.If VaRα is the capital level, then EPD is the expected unconditional loss, and the Default Put is the Market Value. |
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What features does the following risk measure have? (2) E [ Y · e^(cY/EY) ] |
• Captures all the moments • Usuallly only exists if there is a maximum loss |
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What is a Probability Transform? How can we use it to calculate risk measures? |
• A probability transform changes the density function -usually increasing the the density of worse losses • A risk measure (such as mean) can be calculated on the transformed probabilities |
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What is the Esscher Transform? |
f∗(y) = k · e ^ (y/c) · f(y) |
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What is a Complete Market? |
A market where any risk can be sold |
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What Probability Transforms are favored in incomplete markets? (2 and why) |
• Minimum Martingale Transform (MMT) • Minimum Entropy martingale Transform (MET) • They give reasonable approximations for reinsurance prices |
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What transform can be used to model prices for bonds and catastrophe bonds? |
The Mean under the Wang transform closely approximates the market value for bonds and catastrophe bonds |
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What is Blurred VaRα How to calculate Blurred VaR? |
Gives weight to losses depending on how far they are from α Uses η(p) to weigh the losses, with the most weight at Y = F−1(α), and the weight decreasing to either side. E[Y · η(F(Y))] η(p) = e ^ [−θ(p−α)2] θ controls how quickly the weight drops off as we get farther from α |
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What market considerations should an insurer take into account when setting capital? |
1. Some customers want a well capitalized insurer, others want a better price 2. A company with 80% renewal business could afford to lose20% of capital - this would be a meaningful risk metric |
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Why is TVaR a better risk measure than VaR at a given percentile for setting capital levels? |
VaR is the minimum loss excess of a percentile TVaR is the average loss excess of a percentile |
