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Issues with the Smith–Wilson method

Andreas Lagerås and Mathias Lindholm

Insurance: Mathematics and Economics, 2016, vol. 71, issue C, 93-102

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.

Keywords: Smith–Wilson; Discount curve; Yield curve; Interpolation; Extrapolation; Hedging; Totally positive matrix; Solvency II (search for similar items in EconPapers)
Date: 2016
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Insurance: Mathematics and Economics is currently edited by R. Kaas, Hansjoerg Albrecher, M. J. Goovaerts and E. S. W. Shiu

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