13.2 The Architecture of the Rate Generator

The Rate Generator takes as input the information from the Rate Management tables (which include term structure parameters and smoothing technique, and risk-free yield curve yields), Product Characteristic assumptions (OAS), ALM Stochastic Process (risk-free yield curve, number of rate scenarios, risk period at which to compute VaR), Stochastic Rate Index rules (formulas for rate indices), and generates monthly rates and stochastic discount factors for each scenario and monthly bucket.

We take the benchmark securities to be zero-coupon bonds whose yields are stored in Rate Management and identified as the risk-free yield curve.

The Monte Carlo Rate Generator also calculates future rates (for a maturity other than one month) for each scenario and beginning at any month within the modeling horizon. These rates are used by the cash flow engine for repricing events and as market rates within the prepayment function.

The process flow of the Rate Generator depends on the type of term structure model. However, all processes share the same building blocks.