Valuation of long-term liabilities under solvency II – Extrapolation methods for the European interest rate market

  • Marie Wahlers Marie Wahlers

For the upcoming Solvency II framework, the Smith-Wilson method constitutes the extrapolation technique for valuing long-term liabilities. Next to the Smith-Wilson method this paper considersthree other methods to extrapolate the long end of the Euro yield curve. Two of them belong to the popular Nelson-Siegel family and the other represents the equilibrium class of interest rate termstructure models. Evaluated by the models’ ability to reduce volatility for long-term yields and by their extrapolation errors, the Smith-Wilson method performs best. Unlike the other methods, it does not require parameter estimations. Only since mid-2011, when yields have shifted to unprecedentedly low levels, the Smith-Wilson method deteriorates and the Nelson-Siegel model exhibits substantiallybetter tted extrapolations.

Netspar, Network for Studies on Pensions, Aging and Retirement, is a thinktank and knowledge network. Netspar is dedicated to promoting a wider understanding of the economic and social implications of pensions, aging and retirement in the Netherlands and Europe.

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