Comparative analysis of interest rate term structures in the Solvency II environment

Abstract

Purpose

Solvency-II is the current regulatory framework of insurance companies in the European Union. Under this standard, European Insurance and Occupational Pension Authority (EIOPA), as a regulatory board, has established that the Smith–Wilson (SW) model can be used as the model to estimate interest rate curve. This paper aims to analyze whether this model adjusts to the market curve better than Nelson–Siegel (NS) and whether the values set for the parameters are adequate.

Design/methodology/approach

This empirical study analyzes whether the SW interest rate curve shows lower root mean squared errors than the NS curve for a sample of daily prices of Spanish Government bonds between 2014 and 2019.

Findings

The results indicate that NS adjusts the market data better, the parameters recommended by the EIOPA correspond to the maximum values observed in the sample period and the current recommended curve for insurance companies underestimates company operations.

Originality/value

This paper verifies that the criterion of the last liquid point does not allow for selecting an optimal sample to adjust the curve and criteria based on prices without arbitrage opportunities are more appropriate.

Citation

Gonzalez Sanchez, M. and Rodriguez-Sanchez, S. (2021), "Comparative analysis of interest rate term structures in the Solvency II environment", Journal of Risk Finance, Vol. 22 No. 1, pp. 16-33. https://doi.org/10.1108/JRF-04-2020-0067