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Issues with the Smith–Wilson method

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  • Lagerås, Andreas
  • Lindholm, Mathias

Abstract

We analyse various features of the Smith–Wilson method used for discounting under the EU regulation Solvency II, with special attention to hedging. In particular, we show that all key rate duration hedges of liabilities beyond the Last Liquid Point will be peculiar. Moreover, we show that there is a connection between the occurrence of negative discount factors and singularities in the convergence criterion used to calibrate the model. The main tool used for analysing hedges is a novel stochastic representation of the Smith–Wilson method.

Suggested Citation

  • Lagerås, Andreas & Lindholm, Mathias, 2016. "Issues with the Smith–Wilson method," Insurance: Mathematics and Economics, Elsevier, vol. 71(C), pages 93-102.
    • Handle: RePEc:eee:insuma:v:71:y:2016:i:c:p:93-102
    DOI: 10.1016/j.insmatheco.2016.08.009
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    References listed on IDEAS

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    1. Patrick Hagan & Graeme West, 2006. "Interpolation Methods for Curve Construction," Applied Mathematical Finance, Taylor & Francis Journals, vol. 13(2), pages 89-129.
    2. de Kort, J. & Vellekoop, M.H., 2016. "Term structure extrapolation and asymptotic forward rates," Insurance: Mathematics and Economics, Elsevier, vol. 67(C), pages 107-119.
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    Cited by:

    1. Zhao, Chaoyi & Jia, Zijian & Wu, Lan, 2024. "Construct Smith-Wilson risk-free interest rate curves with endogenous and positive ultimate forward rates," Insurance: Mathematics and Economics, Elsevier, vol. 114(C), pages 156-175.

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