Hi, 2(i) on April 2012 paper ask to calculate a best estimate liability for a unit linked product. Part of the answer talks about the be liab having to be market consistent. So future returns will be calibrated to the risk free rate. Is this saying the unit fund is projected forward at a risk free growth rate? It also says volatility assumptions will be required. These will be based on market observations ie implied volatilities. What are the volatilities actually used for here if we are projecting forward at a risk free rate?? Cheers
Future returns can still be stochastic, with an appropriate volatility, but the mean of the distribution will be set equal to the risk-free rate, rather than to some real-world expected return.
