Measuring market and credit risk under Solvency II: evaluation of the standard technique versus internal models for stoc
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Measuring market and credit risk under Solvency II: evaluation of the standard technique versus internal models for stock and bond markets Saeed Asadi1,2 · Mazin A. M. Al Janabi3 Received: 17 October 2019 / Revised: 8 May 2020 / Accepted: 13 May 2020 © EAJ Association 2020
Abstract The 2008–2009 Global Financial Crisis (GFC) has swayed regulators to set forth the Solvency II agreement for determining Solvency Capital Requirement (SCR) for insurance companies. In this paper, we apply novel internal models to investigate whether the latest version of the Solvency II standard model demands sufficient capital charges, both in normal and stressed times, for the different risk categories included in bond and stock portfolios. Because the GFC has shown that extreme events on the tail of probability distributions can occur quite often, our empirical findings indicate that the magnitude of the equity risk using the GJR–EVT–Copula method requires insurers to keep more SCR for stock portfolios than the Solvency II standard model. In the case of a bond portfolio, we conclude that the Solvency II standard model requires approximately the same SCR as our internal model for the higher quality and longer maturity bonds, whereas the standard model overestimates SCR for the lower quality and shorter maturity bonds. At the same time, the standard model underestimates interest-rate risk and overestimates spread risk. Overall, the discrepancies in the estimated SCRs between the Solvency II standard technique and our internal models increase as the level of the risks rise for both stock and bond markets. Our empirical results are in line with other competing internal modeling techniques regarding stock market investment and bond portfolios with the higher quality and longer maturity bonds, while for the lower quality and shorter maturity bonds, the results contradict other modeling procedures. The obtained empirical results are interesting in terms of theory and practical applications and have important implication for compliance with the Solvency II capital requirements. Likewise, it can be of interest to insurance regulators, policymakers, actuaries, and researchers within the field of insurance and risk management. Keywords Insurance · Internal models · Credit risk · Market risk · Standard models · Solvency II · GJR–EVT–copula · Spread risk · Equity risk · Bond risk · Risk management
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S. Asadi, M. A. M. Al Janabi
Fig. 1 Solvency II three-pillar approach
JEL Classification G20 · G22 · G28 · G32 · G38
1 Introduction The 2008–2009 Global Financial Crisis (GFC) is largely considered as a banking crisis, and hence the solvency of the insurance sector as a whole appeared not to be threatened, at least as the initial events of bankruptcies in the financial sector started to unfold. Nonetheless, the GFC had a major impact on the insurance industry as well, primarily through their investment’s portfolios, as the crisis spread and financial
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