Understanding the Connection between Real-World and Risk-Neutral Scenario Generators

Author

Stephen J. Strommen, FSA, CERA, MAAA

Description

Scenario generators used in financial models to quantify risk are sometimes described as being as either “real-world” or “risk-neutral." The difference is in the treatment of the market price of risk. This report explores the relationship between real-world and risk-neutral scenarios and when it is appropriate to use each type.

Materials

Understanding the Connection between Real-World and Risk-Neutral Scenario Generators

Excel-based Tool

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Acknowledgments

The researchers’ deepest gratitude goes to those without whose efforts this project could not have come to fruition: the Project Oversight Group for their diligent work overseeing, reviewing and editing this report for accuracy and relevance.

Project Oversight Group members:
Charles V Ford, FSA, MAAA, CFA
Gary Hatfield, FSA, CERA, CFA, PhD
Jason Kehrberg, FSA, MAAA, PhD
James Kosinski, FSA, MAAA, CFA, PhD
Steve Marco, ASA, CERA
Hal Pedersen, ASA, MAAA, PhD

At the Society of Actuaries Research Institute:
Doug Chandler, FSA, FCIA, Canadian Retirement Research Actuary
Dale Hall, FSA, CERA, CFA, MAAA, SOA managing director of research

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