Risk aggregation in Solvency II through recursive log-normals |
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Institution: | 1. Laboratory of Actuarial and Financial Sciences (LSAF, EA2429), Institute of Financial and Insurance Sciences, University Claude Bernard Lyon 1, France;2. Laboratory Research for Economy, Management and Quantitative Finance, Institute of High Commercial Studies of Sousse, Tunisia |
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Abstract: | It is argued that the accuracy of risk aggregation in Solvency II can be improved by updating skewness recursively. A simple scheme based on the log-normal distribution is developed and shown to be superior to the standard formula and to adjustments of the Cornish–Fisher type. The method handles tail-dependence if a simple Monte Carlo step is included. A hierarchical Clayton copula is constructed and used to confirm the accuracy of the log-normal approximation and to demonstrate the importance of including tail-dependence. Arguably a log-normal scheme makes the logic in Solvency II consistent, but many other distributions might be used as vehicle, a topic that may deserve further study. |
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Keywords: | Clayton copula Cornish–Fisher Moment matching Recursive skewness Standard formula Sum of log-normals |
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