Updating the Ultimate Forward Rate over Time: A Possible Approach

Diana Zigraiova and Petr Jakubík

Working Papers from Czech National Bank, Research and Statistics Department

Abstract: This study proposes a potential methodological approach to be used by regulators when updating the Ultimate Forward Rate (UFR) for the evaluation of insurers' liabilities beyond the last liquid point observable in the market. Our approach is based on the optimisation of two contradictory aspects - stability and accuracy implied by economic fundamentals. We use U.S. Treasury term structure data over the period 1985-2015 to calibrate an algorithm that dynamically revises the UFR based on the distance between the value implied by the long-term growth of economic fundamentals in a given year and the regulatory value of the UFR valid in the prior year. We employ both the Nelson-Siegel and Svensson models to extrapolate yields over maturities of 21-30 years employing the selected value of the UFR and compare them with the observed yields using the mean square error statistic. Furthermore, we optimise the parameters of the proposed UFR formula by minimising the defined loss function capturing both mentioned factors.

Keywords: Extrapolation; Nelson-Siegel; Svensson; term structure of interest rates; Ultimate Forward Rate (search for similar items in EconPapers)
JEL-codes: E43 G22 L51 M2 (search for similar items in EconPapers)
Date: 2017-06
New Economics Papers: this item is included in nep-cba and nep-mac
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Persistent link: https://EconPapers.repec.org/RePEc:cnb:wpaper:2017/03

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