Active market

IFRS 13 Definition: A market in which transactions for the asset or liability take place with sufficient frequency and volume to provide pricing information on an ongoing basis.


Why is market data important?

Many current and emerging regulatory or reporting regimes use the ideas of fair value or market-consistent value of assets and liabilities – Solvency II Technical Provisions, MCEV, IFRS.

The long-term nature of life insurance contracts means that often the relevant instruments for valuation may not traded in „liquid‟ markets – There may be questions over the price reliability of these assets

The decision whether-or-not to include these assets can affect the results of a valuation exercise

Solvency II – Deep, Liquid & Transparent Markets

  • “A deep market is a market in which a large number of assets can be transacted without affecting the price of the financial instruments used in the replications
  • A liquid market is a market where assets can be easily converted through an act of buying or selling without causing a significant movement in the price
  • A transparent market is a market in which current trade and price information is readily available to the public”

Many of the OTC derivates currently used in market-consistent valuations don’t satisfy this definition – what impact will this have?

Example of different markets/Data sources

Traditional data sources

Exchanges

– Excellent source of information if good turnover

– Typically limited to short-dated near ATM

– Each exchange may have a different method to settle contracts

– Last trade may be manipulated

– Settlements can have model-based assumptions

– In illiquid markets, settlements can be stale

– Quote size may be small and not relevant for OTC markets

Model-based pricing services

– Based on limited publicly available information

– No benchmark or validation process

– A single unqualified view of the market

– “Black Box” approach

– Automated process and “best fit” curves may be away from actual prices

– Model assumptions and smoothing techniques may lack transparency

Counter party valuations

– Lack of independence

– No benchmark or validation process

– A single view of the market


 

 

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