Abstract

The incoming IFRS 17 standard will require insurers to adopt market-consistent methods in valuing their insurance contract liabilities. Insurance contracts such as segregated funds categorized as direct participation contracts are highly dependent on the choice of interest rate model. This thesis describes the general steps in the calibrating the G2++ and G3++ short rate models to swaptions. The calibration process is an optimization problem where parameters that minimize the difference between market and model implied prices are determined. We highlight some issues that arise during the calibration such as the choice of a calibration method and an optimization algorithm as well the imposed constraints used in solving this inherent non-convex global optimization problem. An evaluation of the calibrated models' consistency to replicate market volatility surface is made via Monte-Carlo simulations. Then a simulation scheme devoid of discretization errors is provided for the stochastic discount factor, the short rate and bond prices which are useful in market-consistent valuations. We provide an illustration of a market-consistent valuation of a segregated fund fully invested bonds and compare the models' results. Finally, we assess the robustness of the models' calibration to different market data and parameter specification. This is to ensure that the calibrated models provide stable financial results for annual regulatory reporting.