The Meaning of ‘Market Consistent’ - Part 1
Document ID: 2007-904 (previously Issue 4)
Published on: 31st August 2007
Author: Elliot Varnell
There is a dramatic paradigm shift underway in long-term financial risk management and in the valuation of long-term insurance and pensions liabilities. The new thinking uses an apparently simple idea – that we should place the same economic value on long-term financial claims as traded instruments with similar characteristics. This new thinking drives the calculation of the realistic balance sheet of UK life insurance firms and the ‘Market-Consistent Embedded Values’ of European firms. The new calculations give rise to ‘market consistent’ values for long-term financial claims. This is the first of two articles written around the topic of what is meant by a market consistent calibration. Here we will examine the differences in the implicit definition of market-consistent used by different UK life insurance firms. In a following article we will explore some more general issues related to the meaning of market consistency and the methods that are then used to generate pseudo-prices.
