Macroeconomic risk drivers’ inclusion in a Real-World Economic Scenario Generator

The aim of this Master’s thesis is to assess how macroeconomic risk drivers can be included into an Economic Scenario Generator (ESG). A Real-World ESG is a model that simulates risk drivers scenarios which are used to replicate cash-flow (for business simulation purposes) and generate a relatively reliable distribution of the possible outcomes of such cash-flows. Models like these have a wide range of uses, ranging from capital requirements under Solvency II for insurance companies to CRD for banks. Macroeconomic risks, particularly inflation, has a lot of impact on financial markets. In the recent years, we have seen a drastic increase of inflation-indexed products. We will explain what an Economic Scenario Generator is, its characteristics & applications as well as the concepts of risk drivers in a given economy. Then, we will explain the major models for interest rates, inflation and unemployment. Finally, we will make a critical assessment of the various models used in an ESG and how they compare against each other in a Real-World case.