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Nematrian Reference Library

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Pedersen, H., Campbell, M.P., Christiansen, S.L., Finn, D., Griffin, K., Hooker, N., Lightwood, M., Sonlin, S.M. and Suchar, C. (2016)Economic Scenario Generators: A Practical Guidehere

Introduction (partial)

"An economic scenario generator (ESG) is a software tool that simulates future paths of economies and financial markets, and illuminates the nature of risk elements within the economy that drive financial variability. The analysis of a stochastic distribution of possible economic futures, which includes unexpected but plausible outcomes, is critical for testing a business model under a wide variety of economic conditions. …

This publication is intended to serve as an in-depth primer on economic scenario generators. The first half of the publication provides more general information on the nature of economic scenario generators—what they are, how they evolved and how they address regulatory and business needs in the insurance and pension industries. It also addresses essential features of a good economic scenario generator and provides some detailed guidance on important aspects of financial market model specification, model calibration and model validation considerations to assure that the ESG will produce simulation results that are relevant and sufficiently robust and that realistically reflect market dynamics.

The second half of the publication provides technical discussion of some of the essential financial markets aspects of a comprehensive ESG. Description of arbitrage-free considerations, the role of risk-neutral scenarios, and default-free interest rate models are explored with some of the underlying mathematics necessary to understand these considerations. Final chapters provide some important considerations relating to corporate bond models and equity index models, and how these considerations may extend to international and global interactions. …"


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