Checking Risk Neutral Calcs

[2pac Shakur]

How do you know what interest rate to discount claims and charges at?

Thanks

[2pac Shakur]

Right now it looks like each month's 90day treasury is used for claims and charges.

[Academic Actuary]

What is the purpose of the calculation? Risk neutral calculation has a very specific purpose which is to value the cash flows as if they were tradeable assets in a complete market. If the underlying cash flows can't be replicated with tradeable assets then you are assuming that the market price of risk for whatever is generating uncertainty is 0. This may be reasonable if claims are unrelated to economic variables.

If risk neutral valuation is appropriate LIBOR rates are generally preferred to Treasury rates as an arbitrageur would not be able to borrow at Treasury rates.

[2pac Shakur]

This is for cash flows on a VA with a GMWB.

[Genre]

Using risk neutral valuation would give you the market consistent value of your guarantee; that is the value you could sell your guarantee in the market. I guess LIBOR is good, but I have also seen curves bootstrapped from swap rates or treasury.

Note that you cannot use risk neutral projections for anything but finding the CURRENT value of your guarantee. A real-world scenario generator based on historical data and probably another model than lognormal would be required to have meaningful projections.

[WWSituation]

Is it not common knowledge that a risk-neutral option value would use a "risk-free" term structure? It is a big part of what makes the value risk-neutral. Is the question whether or not it is OK to use swap rates as a representation of the risk-free rates?