Forecasting for Solvency Risk

Dec 1, 2005

In this month's note, we consider the problem of solvency risk for pension and insurance firms. The forecasting horizon for this problem, one year, is the same as we considered previously for non-financial corporates. However, the solvency problem is such that we cannot use the same forecasting techniques. Here, we must forecast directly using the price histories, without options information to guide us. Our approach is to utilize a process which fits the data well at horizons up to three to six months (where we have enough data to make such assertions), and which provides a sound theoretical basis to scale to one year (where a purely empirical approach is hopeless).