1. © Brammertz Consulting, 20091Date: 07.03.2016 Unified Financial Analysis Risk & Finance Lab Chapter 6: Behavior Willi Brammertz / Ioannis Akkizidis

2. © Brammertz Consulting, 20092Date: 07.03.2016 Input elements

3. © Brammertz Consulting, 20093Date: 07.03.2016 Multiple roles of Behavior > External contract rules: Rules that cannot be written into the contracts due to their statistical nature > Completion of market and credit risk factors (statistical based) > Behavior as risk factors: The statistical nature introduces new risk categories into the system > Catch-all category: The flexible nature of behavioral patterns makes it a catch-all category

4. © Brammertz Consulting, 20094Date: 07.03.2016 Risk Sources and Behavior > Market related > Insurance related > Credit Related > Operation Related (Chapter 12, 13.4)

5. © Brammertz Consulting, 20095Date: 07.03.2016 Behavior and Market > Market contains elements whose relationship with contracts is stable > Behavior contains elements whose relationship with contracts is unstable > Unstable parameters within stable functions > Unstable functions

6. © Brammertz Consulting, 20096Date: 07.03.2016 Border between Behavior and Market > Conditions to belong into the Market group > Stable relationship between risk factor and contract > Corollary: all mathematical relationships exactly and ex ante known > Conditions to belong into the Behavior group > Unstable relationship between risk factor and contract > Statistical nature of parameters > Corollary: all mathematical relationships not known a-priori > There is a grey area (example PD)

7. © Brammertz Consulting, 20097Date: 07.03.2016 Behavior: an open dimension > Behavior can evolve over time similarly to contract types > The openness poses a challenge to the system > The openness defies simple closed from solutions > No derivations > Monte Carlo needed for all types of analytics > Behavior plays also a catch all role for not yet known risk factors > Example: Enforced change of contract conditions

8. © Brammertz Consulting, 20098Date: 07.03.2016 Examples of behavior

9. © Brammertz Consulting, 20099Date: 07.03.2016 Market related Behavior: Replication Replication of non-maturity contracts = Shadow maturity contracts

10. © Brammertz Consulting, 200910Date: 07.03.2016 Finding the correct replication ! Going-concern based approach !

11. © Brammertz Consulting, 200911Date: 07.03.2016 Market related Behavior: Prepayment > Sales is same mechanism but different actor (and usually mark to market) > Prepayment and Surrender (term used by insurances) is the same

12. © Brammertz Consulting, 200912Date: 07.03.2016 Market related Behavior: Drawing (Also Used at Default)

13. © Brammertz Consulting, 200913Date: 07.03.2016 Insurance related Behavior: Mortality, annuity conversion and surrender > Mortality > Annuity conversion > Surrender = prepayment

14. © Brammertz Consulting, 200914Date: 07.03.2016 Credit risk related Behavior: Migration and PD, Recovery > Migration matrix > Recovery > Amount > Pattern