Associateship Qualification

Economic Modelling (CM2)

Core Principles

Syllabus for the 2026 Examinations

April 2025
Syllabus Economic Modelling (CM2) 2026

Economic Modelling (CM2)

Syllabus for the 2026 Examinations
This syllabus includes information to support the study of this subject. It will guide you through what
you need to learn, application of learning as well as the skills that you need to develop. Information
regarding the assessment of this subject is also included.

This syllabus includes:

• Aim of the subject

• How this subject links across the Qualifications
• Subject topics and topic weightings
• Subject objectives
• Assessment information

Aim
Economic Modelling (CM2) provides a grounding in the principles of actuarial modelling, focusing on
stochastic asset models, the valuation of financial derivatives and develops skills to model economic
decision making, the probability of ruin, estimation of claims and the pricing of assets and options.

Links across the Qualifications

Associateship Curriculum

Concepts that underpin the topics in CM2 are introduced in:

• Actuarial Statistics (CS1)

○ Particularly probabilities, random variables, expectation and variance.
• Risk Modelling and Survival Analysis (CS2)
○ The understanding of random variables and distribution, time series and stochastic processes.
• Mathematics for Modelling (CM1)
○ Understanding of the theory of interest rates and modelling techniques.
• Business Economics (CB2)
○ Familiarity with concepts regarding decision making.

© Institute and Faculty of Actuaries 2

Syllabus Economic Modelling (CM2) 2026

Subjects that are underpinned by CM2 and further develop the topics:

• Actuarial Practice (CP1)

○ Where CM2 skills are applied to real world problems
• Modelling Practice (CP2)
○ Where CM2 modelling techniques applied in a business context
• Communications Practice (CP3)
○ May draw upon concepts and techniques from CM1 in order to answer the CP3
examination questions

Fellowship Curriculum

Skills and techniques from CM2 are developed further in the following Specialist Principles subjects,
with a focus on solving problems, and giving advice, guidance and recommendations:

• SP5 – Investment and Finance Principles

• SP6 – Financial Derivatives Principles
• SP9 – Enterprise Risk Management Principles

Topics & topic weightings

1. Rational economic theory [10%]
2. Measures of investment risk [10%]
3. Asset valuations [30%]
4. Liability valuations [20%]
5. Option theory [30%]

Objectives
1 Rational economic theory [10%]
Theories and modelling techniques used to explore, understand and evaluate rational economic
decision making and asset pricing. In particular, the application of utility functions to financial and
economic problems.
1.1 Understand the principles of rational expectations theory
1.1.1 Three forms of the Efficient Markets Hypothesis and their consequences for
investment management
1.1.2 Evidence for or against each form of the Efficient Markets Hypothesis
1.2 Understand the principles of rational choice theory
1.2.1 Meaning of ‘utility function’
1.2.2 Concept of utility theory and the expected utility theorem

© Institute and Faculty of Actuaries 3

Syllabus Economic Modelling (CM2) 2026

1.2.3 Understand properties of utility functions that express these economic characteristics
of investors:
• Non-satiation
• Risk aversion, risk neutrality and risk seeking
• Declining or increasing absolute and relative risk aversion
1.2.4 Economic properties of commonly used utility functions
1.2.5 Identify how a utility function may depend on current wealth and discuss state-
dependent utility functions
1.2.6 Perform calculations using common utility functions that compare
investment opportunities.
1.2.7 Use utility theory to analyse simple insurance problems

2 Measures of investment risk [10%]

Apply a range of financial risk measurement tools to evaluate investment opportunities in the context
of utility functions. Understand how mitigating actions can reduce risk faced by insurance companies.
2.1 Identify the properties of risk measures and use these risk measures to compare and analyse
investment opportunities
2.1.1 Measures of investment risk:
• Variance of return
• Downside semi-variance of return
• Shortfall probabilities
• Value at Risk (VaR)
• Tail VaR (also referred to as Expected Shortfall)
2.1.2 How the risk measures listed in are related to the form of an investor’s utility function
2.1.3 Compare investment opportunities via calculations using the risk measures
listed in 2.1.1
2.1.4 How the distribution of returns and the thickness of tails will influence the assessment
of risk
2.2 The role of insurance companies in reducing or removing risk
2.2.1 How insurance companies help to reduce or remove risk
2.2.2 The meaning of ‘moral hazard’ and ‘adverse selection’
3 Asset valuations [30%]
The use of models in portfolio selection and asset pricing, including the term structure of interest
rates and credit risk.
3.1 Understand mean-variance portfolio theory and its application
3.1.1 The assumptions of mean-variance portfolio theory
3.1.2 When does the application of mean-variance portfolio theory lead to the selection of
an optimum portfolio

© Institute and Faculty of Actuaries 4

Syllabus Economic Modelling (CM2) 2026

3.1.3 Use mean-variance portfolio theory to calculate the expected return and risk of a
portfolio of many risky assets, given the expected return, variance and covariance
of returns of the individual assets
3.1.4 Benefits of diversification using mean-variance portfolio theory
3.2 Understand and use the Capital Asset Pricing Model (CAPM)
3.2.1 The assumptions, principal results and uses of the Sharpe-Lintner-Mossin Capital Asset
Pricing Model (CAPM)
3.2.2 The limitations of the basic CAPM and some of the attempts that have been made to
develop the theory to overcome these limitation
3.2.3 Perform calculations using the CAPM
3.2.4 Main issues of estimating parameters for asset pricing models
3.3 Understand and use single and multifactor models for investment returns
3.3.1 Three types of multifactor models of asset returns:
• Macroeconomic models
• Fundamental factor models
• Statistical factor models
3.3.2 Single-index model of asset returns
3.3.3 Concepts of diversifiable and non-diversifiable risk
3.3.4 Construction of the different types of multifactor models
3.3.5 Perform calculations using both single and multifactor models for investment returns
3.4 Appreciate different stochastic models for security prices and how and when they can
be applied
3.4.1 Continuous time log-normal model of security prices and the empirical evidence for
and against the model
3.4.2 Basic properties of standard Brownian motion or Wiener process
3.4.3 Principles of stochastic differential equations, the Ito integral, diffusion and
mean-reverting processes
3.4.4 Understand Ito’s Lemma and apply it to simple problems
3.4.5 Describe the stochastic differential equation for geometric Brownian motion
3.4.6 Describe the stochastic differential equation for the Ornstein-Uhlenbeck process
3.5 Understand the principles and characteristics of models of the term structures of interest rates
and their application
3.5.1 Principal concepts and terms underlying the theory of a term structure of interest rates
3.5.2 Desirable characteristics of models for the term structure of interest rates
3.5.3 Apply the term structure of interest rates to modelling various cashflows

© Institute and Faculty of Actuaries 5

Syllabus Economic Modelling (CM2) 2026

3.5.4 Risk-neutral approach to the pricing of zero-coupon bonds and interest-rate derivatives
for a general one-factor diffusion model for the risk-free rate of interest, as a
computational tool
3.5.5 The Vasicek, Cox-Ingersoll-Ross and Hull-White models for the term structure of interest
rates and their limitations
3.6 Understand the principles and application of simple models for credit risk
3.6.1 What is a ‘credit event’ and ‘recovery rate’
3.6.2 Identify the different approaches to modelling credit risk: structural models, reduced form
models, intensity-based models
3.6.3 Understand and apply the Merton model
3.6.4 Understand and apply the two-state model for credit rating with a constant
transition intensity
4 Liability Valuations [20%]
The use of models in insurance to calculate the probability of ruin and estimate claims
4.1 Understand the principles and application of ruin theory
4.1.1 The aggregate claim process and the cashflow process for a risk
4.1.2 Use the Poisson process and the distribution of inter-event times to calculate
probabilities of the number of events in a given time interval and waiting times
4.1.3 Understand the compound Poisson process and calculate probabilities using simulation
4.1.4 The probability of ruin in infinite/finite and continuous/discrete time and state, and the
relationships between the different probabilities of ruin
4.1.5 The adjustment coefficient and Lundberg’s inequality
4.1.6 Understand the effect on the probability of ruin, in both finite and infinite time, of
changing parameter values by reasoning or simulation
4.1.7 Maximisation of the adjustment coefficient under proportional reinsurance and excess
of loss reinsurance
4.1.8 Calculate probabilities of ruin by simulation
4.2 Understand and use run-off triangles to estimate claims
4.2.1 Understand what a development factor is and show how a set of assumed development
factors can be used to project the future development of a delay triangle
4.2.2 Understand and apply a basic chain ladder method for completing the delay triangle
using development factors
4.2.3 Basic chain ladder method and how this can be adjusted to make explicit allowance
for inflation
4.2.4 Understand and apply the average cost per claim method for estimating outstanding
claim amounts
4.2.5 Understand and apply the Bornhuetter-Ferguson method for estimating outstanding
claim amounts

© Institute and Faculty of Actuaries 6

Syllabus Economic Modelling (CM2) 2026

4.2.6 Understand how a statistical model can be used to underpin a run-off triangles approach
4.2.7 Understand the assumptions underlying the application of the methods
in 4.2.1 to 4.2.6 above
4.3 Value basic benefit guarantees using simulation techniques
5 Option theory [30%]
The construction and evaluation of common forward and option contracts as well as theoretical
models for derivatives and option pricing, in particular the theory and application of binomial and
Black-Scholes models.
5.1 Understand the principles of option pricing and valuations
5.1.1 What is meant by arbitrage and a complete market
5.1.2 Factors that affect option prices
5.1.3 Determine specific results for options that are not model dependent:
• Show how to value a forward contract
• Develop upper and lower bounds for European and American call and put options
5.1.4 The meaning of put–call parity
5.2 Understand the principles of the binomial option-pricing model and its application
5.2.1 Use binomial trees and lattices to value options and solve simple examples
5.2.2 Determine the risk-neutral pricing measure for a binomial lattice and describe the
risk-neutral pricing approach to the pricing of equity options
5.2.3 Difference between the real-world measure and the risk-neutral measure and why the
risk-neutral pricing approach is seen as a computational tool (rather than a realistic
representation of price dynamics in the real world)
5.2.4 The alternative names for the risk-neutral and state-price deflator approaches to pricing
5.2.5 Apply the state-price deflator approach to the binomial model and understand its
equivalence to the risk-neutral pricing approach
5.3 Understand the principles of the Black-Scholes derivative-pricing model and its application
5.3.1 The martingale representation theorem
5.3.2 Underlying principles of the Black-Scholes partial differential equation both in its basic
and Garman-Kohlhagen forms
5.3.3 Use the Black-Scholes model to price and hedge a simple derivative contract using the
martingale approach
5.3.4 Value options and solve simple examples using the Black-Scholes model
5.3.5 Apply the state-price deflator approach to the Black-Scholes model and understand its
equivalence to the risk-neutral pricing approach
5.3.6 Validity of the assumptions underlying the Black-Scholes model
5.3.7 Commonly used terminology for the first and, where appropriate, second partial
derivatives (the Greeks) of an option price

© Institute and Faculty of Actuaries 7

Syllabus Economic Modelling (CM2) 2026

Assessment
This subject will be assessed via two online written examination papers.

• CM2 Paper A (CM2A), 3 hours and 20 mins (including reading time)

CM2A will include a number of questions set with varying marks and in line with the topics and topic
weightings. This examination is timed and online.

• CM2 Paper B (CM2B), 1 hour and 50 mins (including reading time)

CM2B is a problem-based examination focusing on modelling skills, requiring you to use data to answer
questions. This examination is timed and online

In order to pass this subject, you must sit both CM2A and CM2B within the same sitting, and achieve a
combined mark of a pass.

Topic weighting

The topic weighting percentage noted alongside the topics is indicative of the volume of content of a
topic within the subject and therefore broadly aligned to the volume of marks allocated to this topic in
the examination. For example if a topic is 20% of the subject then you can expect that approximately
20% of the total marks available in the examination paper will be available on that topic.

Candidates for assessment should ensure that they are well prepared across the entire syllabus.
The examination can be composed of questions drawing from any part of the syllabus within any
examination sitting and using any command verb. This includes knowledge, techniques, principles,
theories, and concepts as specified. Candidates should not rely on past papers alone and should
ensure they have covered the entire syllabus as part of their learning and development of this subject.
A list of command verbs used in the examinations is included on the IFoA website.

In each examination, candidates will be expected to demonstrate, through their answers, that they have
knowledge of, can apply and use higher order skills in this subject:

• Knowledge will be demonstrated through answering questions that assess your understanding of that
knowledge as well as through questions that ask you to apply relevant knowledge to scenarios.
• Application will be demonstrated through answering questions which assess that you can identify and
apply relevant concepts and skills to solve problems (both numerical and non-numerical)
• Higher order skills will be demonstrated through questions that will assess that you can use relevant
knowledge, concepts and skills to solve problems, draw appropriate conclusions, and make
meaningful and appropriate comments on those conclusions.

As a guide, in the examination of this subject, you can expect that approximately 5% of the total number
of marks for this examination be allocated to the demonstration of knowledge, 75% to application and
20% to higher order.

IFoA Guidance and Regulations

Please ensure you have read and understood the Assessment Regulations and Examinations
handbook ahead of your exam. Useful and important information can be found in the Qualifications
Handbook. These are all available on the IFoA website.

© Institute and Faculty of Actuaries 8

Beijing Room 512, 5/F Block A, Landgentbldg Center · No. 20 East Middle 3rd Ring Road Tel: +86 10 6611 6828
· Chaoyang District · Beijing 100022 · People's Republic of China
Edinburgh Space, 1 Lochrin Square · 92-94 Fountainbridge · Edinburgh · EH3 9QA Tel: +44 (0) 20 7632 2100
London (registered office) 1-3 Staple Inn Hall · High Holborn · London · WC1V 7QH Tel: +44 (0) 20 7632 2100
Malaysia Arcc Spaces, Level 30, Vancouver Suite · The Gardens North Tower · Tel: +60 12 591 3032
Lingkaran Syed Putra 59200 · Kuala Lumpur
Oxford Belsyre Court · 1st Floor · 57 Woodstock Road · Oxford · OX2 6HJ Tel: +44 (0) 20 7632 2100
Singapore Pacific Tech Centre · 1 Jln Kilang Timor #06-01 · Singapore 159303 Tel: +65 8778 1784
www.actuaries.org.uk