marketconsistent

Market-consistent valuation is an approach used in finance and insurance to determine the value of assets and liabilities by aligning prices with observable market data and no-arbitrage principles. The central idea is to price cash flows using market prices for the underlying risk factors, often through replication with traded securities or by discounting using market-consistent discount curves that reflect current yields and risk premia. Market-consistent valuation aims to produce prices that would be obtained in an efficient, liquid market, rather than relying solely on internal models or historical costs.

In practice, market-consistent valuation relies on methods such as dynamic replication with traded assets, risk-neutral or equivalent martingale pricing, stochastic discount factors, and calibration to market data including yield curves, volatilities, and credit spreads. It frequently involves forward-looking scenarios and sometimes Monte Carlo simulations to account for the time value of money and uncertainty in future cash flows. The approach is used to value both assets and liabilities in a consistent framework, and to ensure that reported values reflect current market conditions rather than solely actuarial assumptions.

Applications are common in insurance and pensions. Under Solvency II and similar regimes, liabilities are valued using market-consistent principles to reflect the costs of future policyholder obligations in a market-based context. The market-consistent embedded value (MCEV) framework is a related practice that attempts to quantify the value of a life insurance business using market-consistent assumptions.

Critics note that market-consistent valuation depends on the quality of market data and models, can be sensitive to illiquidity and model risk, and may be challenging in incomplete markets. Nevertheless, it remains a widely used standard for transparent, comparable valuations.