Category: replies

Posted on

Clever Doggie

Smarter than your average equity release actuary

Our friend Golden Retriever at golden.retriever@dogs.gov writes in about our last post on the profitability of equity release mortgage loans:

My first thought was that, surely with any investment, you know the profitability only once the asset has been redeemed, sold, or otherwise disposed of. At this point, you don’t need Black 76, or any other model, to work out profitability: you just look at actual cash inflows and outflows. Do I therefore take it that what you are looking at is actually expected profitability?

To quote Churchill:

The trouble with the ex post measure of profitability is precisely that you don’t know it until the loan has been repaid. We are interested in assessing expected profitability because we want to work out the valuations of the NNEG and ERM ex ante, so that firms have solid valuations at the time the loans are taken out. The only alternative ex ante I can think of is a crystal ball that works.

Of course, we recognise that NNEG valuation is a bit of a dog’s dinner.

Continue reading “Clever Doggie”

Posted on

Yet more from the postbag – Leland toft model, covered bonds

A busy day at the Post Office. K9.dogs is still intrigued by our earlier suggestion that the illiquidity premium is only c.5bps. Could we have a blog on that? Indeed, but that will have to wait until next week. Illiquidity premia require patience (unless you are an insurance company).

Max LikeyHood (sic) at maximumlikeyhood@gmail.com asks if we can make our implementation of the Bank’s structural model available. Yes, in the interests of transparency, public disclosure etc, here it is. The usual disclaimers apply – at your own risk, no representation is made etc. There is an additional bonus in that we have included the Basel IRB model at the bottom. Any questions, please ask in the usual way.

And keep up with the weird email addresses!

 

Posted on

From the postbag – Merton model

Source: Bank of England

The Retriever has found another juicy bone. He (or she?) writes in raising a number of points about credit spreads, questioning my suggestion (following John Vickers’ assertion) that credit spreads rose in 2018 ‘Largely, if not wholly, because corporate credit risk has gone up’.

Retriever raises a number of interesting points. For the moment (and in a subsequent post) I will focus on the challenge presented to our case by the Bank of England’s structural credit model. As Retriever points out, Chart E of this 2016 inflation report (page 13 of the PDF, and copied above) suggests that the Bank of England thinks that the illiquidity premium is something like 50% of the corporate bond spread.

Presumably you must think that either 1) the Merton model is inappropriate here; 2) that the BoE has parameterised the Merton model incorrectly; or 3) that this “residual” bit of the spread is accounted for something other than credit and liquidity.

Continue reading “From the postbag – Merton model”

Posted on

From the postbag – various

‘Golden Retriever’ @k9.dog asks ‘What makes you conclude that corporate credit risk increased during 2018?’, presumably referring to my report of John Vickers speech the other day.

Well “average bond spread increased by c.41bps in 2018” should be a clue, taken from the Just Group 2018 regulatory report. May not be correct, but other insurers reported the same thing. Indeed, total spread widening in 2018 caused a fall in asset values of around £7bn – according to another source. Fortunately MA was there to mop up the losses, so there weren’t really any losses at all.

Another actuary, referring to this post  reported proudly that he had managed to listen to 18 minutes 50 seconds of the Wii Shop Channel. Look mate, the whole purpose of that music was to act as a deterrent, and to encourage actuaries to mend their ways. Not an endurance competition. There is some more above (2 hour loop).

Have a good weekend everyone.

Posted on

From the postbag – the illiquidity premium

Two items today. A friend of Eumaeus from Ireland writes to say they are disappointed that we did not cover the Jeffery and Smith paper (Equity Release Mortgages: Irish & UK Experience) as extensively as we might have done. Another friend wrote to express a puzzle about the Matching Adjustment principle.  The principle suggests that we can construct a synthetic non-sovereign bond rate that is risk free, but which has a higher return than a (risk free) gilt, which we can use to discount the future liability. But if the gilt and the synthetic bond are certain to pay the same amount at maturity, how can their returns differ?

Continue reading “From the postbag – the illiquidity premium”