This book reports on an independent study of the Academy of Actuaries Stochastic Log Volatility Interest Rate Model. This is not in any way commissioned by the Academy of Actuaries. This is the start of a series to review the Academy Economic Scenario Generator.
The Academy SLV model is a 3 factor interest rate model. The long term yield mean reverts to a target subject to stochastic volatility. The spread mean reverts to a target. The volatility of the long term rate is mean reverting.
This model is compared to the author's Double Mean Reverting Process (TM) and the improved Regime Switching version of the DMRP. The Double Decay model of Beaglehole Tenney was praised by Bernanke for use in modeling the term structure.
This book is most useful for actuaries who use the Academy of Actuaries SLV model and ESG. It is also useful to actuaries who use the DMRP model. The DMRP is also sometimes called the Two Factor Black Karasinski model. That model is widely used in Europe.
The material is at a basic level of instruction for users who do not have a mathematical background.
The material can be used by actuaries, regulators, risk managers, and those involved in providing services to the above based on interest rate risk management. It is less oriented to retail investors or insurance buyers or brokers. All use is at the user's own risk with no warranty.
This material is a supplement to a presentation by Faye Albert and Mark S. Tenney at the Sep 12-13 2011 Valuation Actuary Symposium of the Society of Actuaries.
Actuarial students and finance students may gain insights into interest rate models and risk management using this material.
About the Author
Formulas developed by the author with David Beaglehole are widely cited. One can search Beaglehole Tenney, quadratic term structure models, Double Decay Model, Green's functions finance, etc. to find more information. These formulas are cited on the webpages of the Federal Reserve, Bank of England, and European Central Bank.
Mark Tenney has provided assistance to the Academy of Actuaries since the 1990's on economic scenario generators and on several projects of the Academy including C3 Phase II and C3 Phase III on economic scenario generators, UVS a precursor to the present reforms in reserving and capital, Equity Indexed Annuities in the 1990's, and modeling efficiency.