Star ESG
Real-World Economic Scenario Generation
Star ESG
Real-World Economic Scenario Generation
Overview of Star ESG
Star ESG is a leading software toolkit providing
financial modeling and risk analytics to the
insurance, pension and banking communities.
Star ESG is used by our clients to manage
and report on risk exposures in excess of
US$3 trillion, and forms a key component of
the advice driving our fiduciary mandates.
Star ESG is a fully coherent and integrated
stochastic Monte Carlo generator covering a
wide array of economic and financial risk metrics
including interest rates, credit spreads, equities,
property, FX and many alternative series. These
metrics are then used to determine the full
distribution of returns at one-year and multiyear
projections for a wide range of assets (and at both
aggregate and individual-security-level detail).
As you navigate the regulatory seas, Star ESG
provides a fully transparent framework ensuring
easy adoption, validation and ownership of the
calibration, analytics and sensitivities that drive
your business. Every line of code is visible, audited
and documented, easing the regulatory burden.
Star ESG is supported by a team of over 50
consultants who have academic and commercial
experience in this field. Specialties include
economics and econometrics, capital and risk,
actuarial advisory, asset pricing, trading, risk
management and systems engineering.
Europe
31
North
America
18
2 towerswatson.com
Over 50
clients
globally
Asia
Pacific
3
Figure 1. Igloo software
Example model
Economic scenario generation (ESG)
Operational features
At a high level, Star ESG is a suite of tools supporting
clients with the assessment of economic and
financial risk. Technically, these tools provide a
coherent and integrated, arbitrage-free, real-world
ESG. They use best-of-breed technical models to
simulate the full range of possible outcomes for the
economic and financial series driving market risk. Star
ESG focuses on economic realism, both regarding
the direct economic items modeled and how these
measures subsequently impact movements in asset
series returns. Furthermore, Star ESG incorporates
a full suite of asset and portfolio analytics to ensure
that series move coherently. Coherence is also
captured by an econometric cascade and tail copula
framework. A tail copula helps ensure we capture the
changes in correlation as market movements become
more extreme.
The ESG is calibrated quarterly and can be used to
project monthly, quarterly or annual scenarios (or
indeed any other custom time interval). Moreover,
users can update the starting values as frequently
as daily, always ensuring that full audit trails remain
for anything modified.
The Star ESG calibration is focused on the full
distribution of results, including the tails, average
levels and volatilities — not only at one-year but
also at multiyear horizons. This ability to model both
short- and long-term risks via the same modeling
framework supports the coherent assessment of
firmwide risk as advocated by modern enterprise risk
management (ERM).
Consequently, Star ESG is appropriate for risk
management, determination of capital, business
planning, hedging strategies, portfolio construction
and holistic ERM.
To date, the ESG generates series for the following
currencies: Argentine pesos, Australian dollars,
Brazilian reals, Canadian dollars, Chinese yuan,
Czech korunas, Danish kroner, euros, Indian rupees,
Japanese yen, Mexican pesos, Norwegian kroner,
South African rand, South Korean won, Swedish
kronor, Swiss francs, U.K. pounds and U.S. dollars.
The Star ESG library can be deployed to clients as
a toolkit library based on Towers Watson’s Igloo
software platform. This is a high-speed, parallelized,
scalable, stochastic simulation platform capable
of running over one million scenarios. Alternatively,
clients can purchase pre-generated simulations.
In each case, calibrations come complete with
comprehensive documentation, training and support.
The ESG output simulations can be exported in
CSV or text-file format and to databases for feeding
to downstream applications, including (among
others) Igloo, Remetrica, Simulum and Risk Explorer
software platforms.
Star ESG 3
Figure 2. Example inputs
Model Selection Table
U.K.
pounds
U.S.
dollars
Interest rates
✔
✔
✔
Equity
✔
✔
✔
GDP
✔
✔
✔
Property
✔
✔
✔
Wage inflation
✔
✔
✔
Inflation
✔
✔
✔
Credit spreads
✔
✔
✔
FX
✔
euros
Danish
kroner
Canadian
dollars
Swedish
kronor
✔
IR based on spread over U.S. YC
Dividend yield
✔
✔
✔
Real rates
✔
✔
✔
LIBOR spots
✔
✔
✔
✔
Federal funds
RPI
✔
Indices Filter
Global_Equity
✔
Hedge_Fund
✔
HFRX_Absolute
✔
HFRX_EqualWeight
✔
HFRX_EquityHedge
✔
HFRX_EquityMN
✔
HFRX_EventDriven
✔
HFRX_Macro
✔
HFRX_RelativeValueArb
✔
HFRX_USConvert
✔
HFRX_USDistrssed
✔
HFRX_USMarketDirectional
✔
HFRX_USMergerArbitrage
✔
HY_Global
✔
HYEM_Sov_Credit
✔
Private_Equity
✔
Property_Equity
✔
4 towerswatson.com
ESG control
The Star ESG library provides considerable
flexibility for users to tailor the parameterization
of the ESG to their risk profile. The model
structure and parameters are fully transparent,
and every line of code is visible. Users can
view all model inputs, change the calibration
parameters, and update the starting yield
curves and rates. In addition, it is possible to
control the ESG output directly using REVO,
a tool that allows users to blend their views
with the ESG. This works by re-weighting the
ESG output simulations, transforming the
series toward the target view. It is possible
to set coherent targets for multiple economic
series and to specify a path of each view. This
approach has the benefit that it is much more
simple and intuitive to use than adjusting the
ESG calibration parameters directly. REVO
has been used to align asset returns with
the business plan or fund manager return
expectations, and is often used for stochastic
stress testing. This can assess the capital
impact of extreme “what if?” scenarios
such as rising inflation and interest rate
environments, or a period of stagflation.
Australian
dollars
“The Star library can be deployed to clients
as a toolkit run on Towers Watson’s Igloo
software platform.”
Figure 3. Example of results
Correlation Report
Rate
inflation
Wage
inflation
Cash
rate
GDP
FX
FED
rates
Prime
rates
1Y spot
rate
4Y spot
rate
10Y
spot
rate
1Y real
spot
rate
4Y real
spot
rate
10Y
real
spot
rate
Rate inflation
100.00%
21.453%
26.560%
3.036%
5.932%
5.932%
28.798%
29.373%
35.185%
-39.240%
-12.842%
Wage inflation
21.453%
100.00%
7.803%
7.919%
6.130%
6.130%
5.395%
-0.600%
-2.606%
-10.339%
-12.275%
-8.436%
Cash rate
26.560%
7.803%
100.00%
38.412%
43.812%
43.812%
92.979%
56.663%
31.478%
-16.093%
21.548%
10.004%
3.036%
7.919%
38.412%
100.00%
15.017%
15.017%
41.438%
37.939%
25.104%
-16.815%
3.043%
8.445%
FED rates
5.932%
6.130%
43.812%
15.017%
100.00%
100.00%
43.529%
41.25%
25.349%
-3.889%
17.708%
15.430%
Prime rates
5.932%
6.130%
43.812%
15.017%
100.00%
100.00%
49.529%
41.257%
25.349%
-3.889%
17.708%
15.430%
1Y spot rate
28.978%
5.395%
92.979%
41.483%
49.529%
49.529%
100.00%
79.322%
55.836%
-7.81%
37.882%
33.252%
4Y spot rate
29.373%
-0.500%
56.663%
37.939%
41.257%
41.257%
79.322%
100.00%
89.549%
-10.811%
42.899%
56.337%
GDP
-2.015%
FX
10Y spot rate
35.185%
-2.606%
31.478%
25.104%
25.349%
25.349%
56.836%
89.549%
100.00%
-18.130%
29.610%
51.854%
1Y real spot rate
-39.240%
-10.339%
-16.093%
-16.815%
-3.889%
-3.889%
-7.817%
-10.811%
-18.130%
100.00%
67.544%
50.152%
4Y real spot rate
-12.842%
-12.275%
21.548%
3.043%
17.708%
17.708%
37.882%
42.899%
29.610%
67.544%
100.00%
88.446%
10Y real spot rate
-2.015%
-8.436%
10.004%
8.445%
15.430%
15.430%
33.252%
55.337%
51.854%
50.152%
88.446%
100.00%
1Y LIBOR swap rate
3.434%
-3.565%
23.964%
-1.112%
10.560%
10.560%
33.417%
33.821%
24.332%
31.476%
40.079%
31.671%
4Y LIBOR swap rate
29.825%
0.685%
61.218%
38.638%
33.695%
33.695%
80.780%
92.694%
79.247%
-11.326%
37.704%
49.189%
10Y LIBOR swap rate
37.536%
1.375%
55.262%
39.718%
27.586%
27.586%
72.596%
88.268%
82.106%
-23.390%
25.436%
40.244%
Credit spread A 4Y
15.512%
8.678%
-32.715%
-35.194%
-24.836%
-24.836%
-38.101%
-50.835%
-48.465%
36.298%
4.498%
-6.899%
Credit spread AAA 4Y
-14.522%
8.587%
-32.735%
-33.464%
-25.345%
-25.345
-37.004%
-48.470%
-46.071%
35.965%
4.935%
-5.520%
Equity total return
5.385%
13.567%
16.158%
39.937%
7.110%
7.110%
25.886%
36.671%
30.515%
-2.554%
16.012%
27.925%
Equity dividend yield
-8.065%
6.050%
-21.285%
29.109%
-20.595%
-20.595%
-29.076%
-39.398%
-32.405%
9.763%
-15.110%
-23.638%
AAA
-13.930%
8.618%
-32.813%
-32.283%
-25.471%
-25.471%
-36.258%
-46.814%
-44.404%
36.214%
5.585%
-4.323%
AA
-13.634%
8.297%
-32.053%
-31.540%
-25.693%
-25.693%
-36.258%
-47.070%
-44.743%
34.150%
3.926%
-5.903%
A
-15.217%
8.746%
-32.960%
-34.663%
-24.974%
-24.794%
-37.875%
-50.141%
-47.750%
36.603%
4.815%
-6.296%
BBB
-17.212%
8.539%
-32.654%
-37.911%
-24.567%
-24.567%
-40.057%
-55.182%
-52.928%
36.081%
2.710%
-10.066%
BB
-18.806%
7.320%
-30.727%
-39.751%
-24.405%
-24.405%
-41.288%
-59.696%
-57.884%
32.118%
-2.263%
-16.228%
B
-18.712%
6.386%
-27.803%
-39.369%
-23.510%
-23.510%
-41.327%
-62.211%
-60.694%
25.822%
-7.738%
-22.263%
CCC
-18.259%
5.627%
-19.480%
-38.055%
-11.547%
-11.547%
-34.523%
-55.679%
-54.515%
21.181%
-6.016%
-21.290%
Property
27.948%
4.031%
53.540%
30.453%
23.019%
23.019%
57.165%
43.473%
30.152%
-6.464%
24.539%
22.056%
Star ESG 5
Figure 4. Sample projected spot rate yield curve
€ – December 31, 2014
Spot rate
Spot rate
US$ — December 31, 2014
9%
8%
9%
8%
7%
7%
6%
6%
5%
5%
4%
4%
3%
3%
2%
2%
1%
1%
0%
0%
0
2
4
6
8
10
12
14
16
18
0
22
20
2
4
6
8
10
12
14
16
18
Term
22
20
Term
90th percentile 75th percentile 50th percentile 25th percentile 10th percentile Mean
Asset modeling
“The assets are valued
directly using the yield
curves and credit spreads
from the ESG.”
The Star ESG library contains a suite of models
for a wide range of asset classes. The assets are
valued directly using the yield curves, credit spreads
and other economic items feeding directly from the
ESG. This preserves coherence between the asset
returns and the underlying economic drivers from
the ESG so the market risk for assets and liabilities
will be assessed consistently. This is essential
for a holistic, firm-level framework used for asset/
liability modelling (ALM) and capital setting. The
asset model simulates migrations and defaults for
every bond using the stochastic transition matrix
generated by the ESG. It is possible to model groups
of bonds and individual securities. Rules can be
specified for the evolution of the asset portfolio
through time. The asset model provides the option
to hold bonds to maturity and then reset them, or
reset them each quarter or year. At the end of each
projection period it is possible to rebalance assets
between asset classes and currencies.
To date, the asset model includes the following
asset classes:
•
•
•
•
•
•
•
6 towerswatson.com
Government bonds
Corporate bonds
Floating-rate notes
Municipal bonds
Inflation-linked bonds
MBS and CMO
Equities
•
•
•
•
Property
Swaps
Derivatives
Alternative assets, including hedge funds, private
equity and commodities
Supporting regulatory compliance
The Star ESG library supports clients’ regulatory
submissions, including Solvency II requirements,
to understand, own and use the models. The open
architecture, transparent code and documentation
allow users to understand each model to a degree
that would be impossible in a black-box setting.
The ability to control the calibration assumptions
and blend views using REVO facilitates ownership
of the modeling results — an essential prerequisite
for developing the trust required to use the model
for ALM or for setting business strategy.
Star ESG users are also supported throughout
the regulatory process. Star ESG licensees
receive documentation corresponding to Solvency
II Level 1, Level 2 and Level 3 — detailing
models, assumptions, limitations, calibration
and validation processes — directly supporting
client Solvency II regulatory submissions. In
addition, the Star ESG team has considerable
experience responding to questions and supporting
clients in regulatory meetings, where helpful.
Consultancy support
Towers Watson is a leading global consultancy firm, providing tailored,
value-added investment advice. In addition to providing financial
systems such as Star ESG, we provide a full range of investment
consulting services to our clients, including advice in the areas of
governance, investment risk management, investment strategy, and
manager selection and monitoring. We have a global network of over
700 investment consultants. Our professional staff is drawn from a wide
variety of backgrounds and disciplines, including actuarial work, fund
management, pension management and consulting.
Why choose Star ESG?
Over 60 clients globally, including some of the largest financial services
providers, have chosen the Star ESG risk management framework.
Star ESG has been chosen as the ESG platform for the following
reasons:
• The technical models generate realistic outputs that can be used
to assess risk coherently in an integrated framework, whether for
capital setting, business planning or ALM.
• The toolkit transfers control and understanding of the modeling
to clients because the code and architecture are transparent. The
calibration parameters are all visible and can be changed, while
REVO can be used to blend views into the ESG.
• The models and documentation support regulatory submissions,
including Solvency II.
• Towers Watson offers a range of consultancy and advisory services
to support the tools.
Further information
For further information, please contact:
Alun Marriott
+44 20 7227 2926
[email protected]
Jon Mossman
+1 215 246 7414
[email protected]
Star ESG 7
About Towers Watson
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company that helps organizations improve performance through
effective people, risk and financial management. With 14,000
associates around the world, we offer solutions in the areas
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