Author: kd

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Real Risk-Free Rate or Deferment Rate?

The PRA’s Consultation Paper CP 7/19 makes some sensible points on a number of issues, but one proposal is a bit bonkers. We refer to S2.4 where it proposed “to take account of movements in real risk-free rates when setting the deferment rate,”’ in order to prevent variability in the real risk-free rate causing variability in the forward rate:

The PRA would increase (reduce) the deferment rate if the review shows there has been a material increase (reduction) in long-term real risk-free interest rates since the last update.

In an earlier post, however, we showed that the deferment rate is equal to the current net rental yield, i.e. the nominal net rental payment divided by the current nominal house price. The real risk-free rate does not even enter into it!

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Just One More Thing

A penny for your Thoth

Kevin Dowd 3 July 2019

Or maybe a couple of things. Still working on the baffling case of the logic of the Matching Adjustment, and I wonder if even Columbo could solve this one.

Let’s sweep aside the objections of the Doubting Thomases (here, here, here etc.) that MA is theoretically flawed. Perhaps IFoA president-elect John Taylor is right when he claimed that MA is not only a Fundamental Actuarial Principle but sound too.

But then I struggle with implementation. You take your credit spread, which is known. You decompose the spread into the Fundamental Spread, the risky bit, and the Matching Adjustment, which is the non-risky bit. I still don’t quite understand the bit about some of the spread above risk-free being risk-free, but that might be me so let’s move on.

Ah yes, you say. Implementation is easy. You just apply the regulatory formula.

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More (Project) Fear Mongering from the Guv’nor

Kevin Dowd 25 June 2019

Governor Carney is up to his old tricks again. To quote Friday’s Financial Times:

Mark Carney, the Bank of England governor, has dismissed Boris Johnson’s claim that Britain’s exporters would avoid facing EU tariffs after a no-deal Brexit.

In an interview with the BBC’s Today programme on Friday, Mr Carney said tariffs would be applied “automatically” if there was no agreement with the bloc because the EU would need to follow World Trade Organization rules. These require that all members apply the same tariffs to all of their trading partners with whom they do not have a free trade agreement

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Hey Presto! The Disappearing Risk Trick

Explain why the Matching Adjustment is a fundamental principle of actuarial science

Dean wrote in his last posting that the exam question posed by Craig Turnbull’s thoughtful piece on Matching Adjustment was whether the MA, whose purpose is to provide a measure of long-term credit default risk, actually delivers a ‘good measure’ of this risk.

Turnbull sets out a deceptively simple looking problem. Suppose we hold a well-diversified portfolio of MA-eligible 10-year zero-coupon non-financial corporate bonds. All the bonds have a BBB public credit rating and a yield to maturity of 2.5%. The 10-year risk-free yield is 1.0% and so the bond credit spread is 1.5%. The problem is to work out this bond’s capital requirement.

He continues:

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Barclays Case Proves that UK Banks are NOT Adequately Capitalised

Shortly after the Adam Smith Institute/Cochrane/Dowd bank capital report came out on May 1st, the Bank of England has inadvertently confirmed our report’s core message – that UK banks are far from being adequately capitalised.

Sir John Vickers and I have been trying to tell the Bank this for years, and yet the BoE still remains in denial on this most important of prudential questions.

To quote a story in today’s Financial Times (“Bank of England warned criminal charge could destabilise Barclays” 15 May 2019):

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UK Banks Still Need Much Higher Minimum Capital Standards

What with all the recent excitement about Matching Adjustment, Age Co and the PRA’s unfailable insurance stress tests, I clean ran out of time to report on the Adam Smith Institute’s new report on bank capital (report, press release) released last week. This new report includes chapters by John Cochrane, ASI research director Matthew Lesh and yours truly.

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More on Jonathan Ford on the UK’s Undercapitalised Banks

Kevin Dowd, 5 December 2018

Capital heaven

Dean wrote positively yesterday about Jonathan Ford’s Financial Times piece “The Illusion of UK bank capital strength,” published on 2 December 2018.

Jonathan is right to warn about UK banks being under-capitalised and it’s good to see a journalist of his standing picking up on this issue.

It is however disheartening to see some of the disgraceful abuse made in the ‘comments’ section underneath his article. “Please keep comments respectful,” the guidelines say. “By commenting, you agree to abide by our community guidelines and … terms and conditions.”

Maybe the FT should consider introducing a moderation process to filter out such abuse in future.

Turning to the subject at hand:

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The Search for the Holy Grail

“We believe more research needs to be completed”

Kevin Dowd 3 December 2018

Chris Cundy at InsuranceERM has just written a nice piece on Dean’s and my new report, Equity Release: A New Equitable in the Making published by the Institute for Applied Economics, Global Health, and the Study of Business Enterprise in their Studies in Applied Economics series. This new report is a follow-up to the Adam Smith Institute report Asleep at the Wheel: The Prudential Regulation Authority and the Equity Release Sector published on August 6th. To quote Chris’s article:

More criticism has emerged from Dean Buckner and Kevin Dowd on the valuation approach taken by some UK insurers investing in equity-release mortgages (ERMs) [who] earlier this year published a critique [Asleep at the Wheel] of how the no-negative equity guarantee (NNEG) element of ERMs was being under-valued, which results in ERM portfolios being over-valued.

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Is Equity Release Another Equitable in the Making?

Kevin Dowd and Dean Buckner, 29 November 2018

Our new report, “Equity Release: Another Equitable in the Making” has just been released in the Studies in Applied Economics series edited by Steve Hanke. Steve is professor of applied economics and co-director of the prestigious Institute for Applied Economics, Global Health, and the Study of Business Enterprise at The Johns Hopkins University in Baltimore, Maryland. We are very grateful to Steve for publishing it.

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