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Aggregation of Market Risks using Pair-Copulas

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Abstract

The advent of the Internal Model Approval Process within Solvency II and the desirability of many insurance companies to gain approval has increased the importance of some topics such as risk aggregation in determining overall economic capital level. The most widely used approach for aggregating risks is the variance-covariance matrix approach. Although being a relatively well-known concept that is computationally convenient, linear correlations fail to model every particularity of the dependence pattern between risks. In this paper we apply different pair-copula models for aggregating market risks that represent usually an important part of an insurer risk profile. We then calculate the economic capital needed to withstand unexpected future losses and the associated diversification benefits. The economic capital will be determined by computing both 99.5th VaR and 99.5th ES following the requirements of Solvency II and SST

Suggested Citation

  • Dominique Guegan & Fatima Jouad, 2012. "Aggregation of Market Risks using Pair-Copulas," Documents de travail du Centre d'Economie de la Sorbonne 12031, Université Panthéon-Sorbonne (Paris 1), Centre d'Economie de la Sorbonne.
    • Handle: RePEc:mse:cesdoc:12031
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    Keywords

    Solvency II; risks aggregation; pair-copulas; diversification gains; market risks; economic capital;
    All these keywords.

    JEL classification:

    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies

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