The Mechanics of a Stochastic Corporate Financial Model

Much has been written in recent years about the types of factors that should be considered in a dynamic financial analysis model. Much less has been written that actually provides a reader with an understanding of how the various pieces of a dynamic financial analysis model need to fit together. This paper is intended to provide a reader with a look “under the covers” at the structure of a model being used for dynamic financial analysis. A second and equally important aspect of dynamic financial analysis is the determination of appropriate, or at least reasonable, parameters for different elements within the model’s mechanical framework. Unfortunately, those organizations that have been the most active in the development of model parameters are in the uncomfortable position of having to choose between divulging the specifics of their parameterization studies, at the risk of losing a competitive advantage, or keeping the knowledge to themselves, to the long-term detriment of the actuarial profession’s ability to effectively use models of this nature. The authors of this paper are no less constrained by our respective organizations. As such, we have largely excluded model parameterization from the subject matter of this paper.