Internal model for spread risk under Solvency II

Sammanfattning: In May 2009 the European Commission decided on new regulations regarding solvency among insurance firms, the Solvency II Directive. The directive aims to strengthen the connection between the requirement of solvency and risks for insurance firms. The directive partly consists of a market risk module, in which a credit spread risk is a sub category. In this thesis a model for credit spread risk is implemented. The model is an extended version of the Jarrow, Lando and Turnbull model (A Markov Model for theTerm Structure of Credit Risk Spreads, 1997) as proposed by Dubrana (A Stochastic Model for Credit Spreads under a Risk-Neutral Framework through the use of an Extended Version of the Jarrow, Lando and Turnbull Model, 2011). The implementation includes the calibration of a stochastic credit risk driver as well as a simulation of bond returns with the allowance of credit transitions and defaults. The modeling will be made with the requirements of the Solvency II Directive in mind. Finally, the result will be compared with the Solvency II standard formula for the spread risk sub-module.