CONCEPT DOCUMENT

ECONOMIC SCENARIO GENERATOR- UNDERSTANDING NEEDS AND REQUIREMENTS IN INDIAN MARKET.

  1. What is an Economic Scenario Generator (ESG)?
  1. An economic scenario generator refers a model which can project economic values.
  1. Used for
  2. Different asset classes
  3. Different product areas
  4. Different sectors
  1. Asset classes include
  1. Equities
  2. interest rates
  3. inflation
  4. Derivatives
  5. Exchange rate/ currency
  6. Property
  1. Product areas include
  1. Capital measurement
  2. Product communications & advice
  3. Product design & governance
  4. Risk & Capital Management
  1. Sectors include
  1. Asset and wealth management
  2. Insurance
  3. Pension fund
  4. Retail distribution
  5. Consultancy
  1. The economy move in relation with many parameters.
  2. Which lead to many possible values on projection, it could be a single value as well in certain circumstances.
  3. The model which take care of the scenarios or distribution of values turn out to be a stochastic model.
  4. In case of single scenario, the model would be deterministic.
  1. A single set of scenarios may not suit for different needs.
  2. The process of creating ESG involves the stages of actuarial control cycle as specify the problem, develop the solution and monitoring experience.
  1. Why do we require ESG
  1. The market is ever changing, uncertain and unpredictable.
  2. Factors influencing the financial market can be modelled, as it exhibits structure and shape over short and long term.
  3. Predicting uncertain events of the financial market require creating/ replicating possible scenarios
  1. By forecasting future
  2. By projecting past
  3. By observing present
  1. Helps to reduce uncertainty for key financial decision making and reduce risk.
  2. For pricing a financial product with optimum accuracy level
  3. Evaluating contingent cash flows of all future times
  1. Approaches for generating economic scenarios
  1. real world scenario
  2. market consistent scenario
  1. Real world scenario generators
  1. Calibrated to historical economic data
  2. Reflect real world volatility
  3. Preferred for longer term capital management
  1. Market consistent scenario generators
  2. Replicate market option prices
  3. Provide arbitrage free scenarios
  4. Preferred for pricing of complex financial instruments
  1. Market consistent scenarios show greater volatility than real world scenarios.
  1. Inputs and models
  1. Inputs leading to generation of real world scenarios include initial conditions, normative assumptions, calibration parameters and economic data, including interest rates, GDP, inflation, earnings yield, dividend yield and equity risk premium of the economy
  2. Input market prices for market consistent scenarios
  3. Number of models available in the market developed by organisations/ companies specialised in risk management and/or economic scenario generation based on different requirements of users.