8.23 (Mandatory – Stochastic) Defining Stochastic Rate Indexing Rules

The Stochastic Rate Indexing rule is a required assumption rule, that you select within a Stochastic ALM Process to calculate Value at Risk and Earnings at Risk.

The purpose of the Stochastic Rate Indexing Rule is to establish relationships between a risk-free Interest Rate Code (IRCs) and other interest rate codes or Indexes used for repricing existing business and pricing new business. The Stochastic Rate Indexing rule allows you to select the valuation curve that the system uses during stochastic processing. Within a Rate Index rule, you can define the relation of the valuation curve to the index curve for multiple currencies.

Stochastic Monte Carlo or Historical simulation is a single factor modeling of interest rates of Reporting Currency. Although the engine does convert Balances into Reporting Currency, there is no correlation of Risk factors of Currency’s Interest rates with Reporting Currency. Stochastic processing is not intended for Multi-currency processes. For best results, run Historical or Monte Carlo calculation for a single currency where Functional Currency = Reporting Currency.

During Stochastic ALM processing, the system generates future interest rates for the valuation curve you selected, which are then used to derive the future interest rates for any Index associated with that valuation curve based on the relationship you define. The rates thus forecasted for the IRCs or Indexes depend on the risk-free curve used for the valuation of instruments associated with the derived IRCs or Indexes. As the risk-free rates change, the non risk-free interest rates change accordingly.