Do Jumps Matter in the Long Term? A Tale of Two Horizons

Jean-François Bégin
Simon Fraser University
Friday, March 26, 2021 - 12:00pm to 1:00pm

Economic scenario generators (ESGs) for equities are important components of the valuation and risk management process of life insurance and pension plans. Because the resulting liabilities are very long-lived and the short-term performance of the assets backing these liabilities may trigger important losses, it is thus a desired feature of an ESG to replicate equity returns over such horizons. In light of this horizon duality, we investigate the relevance of jumps in ESGs to replicate dynamics over different horizons and compare their performance to popular models in actuarial science. We show that jump-diffusion models cannot replicate higher moments if estimated with the maximum likelihood. Using a generalized method of moments-based approach, however, we find that simple jump-diffusion models have an excellent fit overall (moments and the entire distribution) at different time scales. We also investigate three typical applications: the value of one dollar accumulated with no intermediate monitoring, a solvency analysis with frequent monitoring, and a dynamic portfolio problem. We find that jumps have long-lasting effects that are difficult to replicate otherwise, so yes, jumps do matter in the long term.

This is joint work with Mathieu Boudreault.

Bio: Jean-François Bégin, PhD, FSA, FCIA is an Assistant Professor in the Department of Statistics and Actuarial Science at Simon Fraser University. His research interests include financial modelling, financial econometrics, filtering methods, high-frequency data, credit risk, option pricing, and pension economics. Before joining SFU, he received his PhD from HEC Montréal.