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ABSTRACT
KEYWORDS
|. INTRODUCTION
and
oo
(2.1)
i o
Q ( x ) dx < oz.
i o~ x [ - d Q ( x ) ]
0
< oo,
i oo x q ( x ) d x
0
< oo.
We need to distinguish two cases: Q(0) < ~ , and Q(0) = oo. In the first case,
{S(t)} is a c o m p o u n d Poisson process with Poisson parameter Q(0) and
individual claim amount distribution
Q(y)
(2.3) P(y) = 1 - - - , y>_ o.
Q (0)
RISK THEORY WITH THE GAMMA PROCESS 179
This is the classical model for collective risk theory. Conversely, every
compound Poisson process, given by Poisson parameter 2 and individual claim
amount distribution P(y), is of this type if we set
(2.4) Q(y) = 2 [ l - P ( y ) ] , y >_ 0.
In the second case, {S(t)} is the limit of compound Poisson processes, but is
not a compound Poisson process itself, because the expected number of claims
per unit time, Q(0), is infinite. Indeed, with probability one, the number o f
claims in any time interval is infinite. Nevertheless, S(t) is finite, as the
majority of the claims are very small in some sense. In both cases, Q(y) is the
expected number of claims per unit time with an amount exceeding y.
Since {S(t)} is the limit of {S(t; x)} as x tends to 0, we can use well-known
results for the compound Poisson process to obtain results for the process
{S(t)}. For example, it follows from
~
= txQ(x)+t Q(y)dy
X
that
{ EI
E[e-~S(';x) 1= exp tQ(x)
x
e-ZYdP(y;x)-ll}
= exp [e - ~ y - 1] [-dO(y)] }.
Letting x ~ 0, we obtain
The process {S(t)}, defined by the function Q(x), has independent, stationary
and nonnegative increments, and E[S(t)] < oo. The converse is true in the
following sense. Every process {X(t)} with these properties is of the form
X(t) = S(t)+bt,
where {S(t)} is a process of the type presented above and b is a nonnegative
constant. This is a consequence of the connection between processes with
180 FRAN(~OIS DUFRESNE, HANS U. GERBER AND ELIAS S.W. SHIU
3. THE G A M M A PROCESS
= exp at dy
:(£)o o Y
(3.4)
is indeed finite.
F o r ~ > 0,
which is a g a m m a density.
F o r - 1 < ct < 0, Q (0) = oo. When ct -- 0, we have the g a m m a process. T o
determine the probability density f u n c t i o n f ( x , t) o f S ( t ) for - 1 < ~t < 0, we
apply f o r m u l a (2.6),
(3.9) E[e-~S(')] = etOq,(~),
with
oo
(3.1 O) ~o(z) =
s o
( e - : Y - - l) y ~ - I e-bY d y .
F r o m ~o(0) = 0 and
i o ( z + b ) ~+1
we obtain
(Note that (3.12) is also valid for ~ > 0; in this case it can derived by first
expressing (3.10) as the difference of two convergent integrals.) For simplicity,
assume a = - I/F(~) and b = 1. Write ,6' = - ~ . Then (3.9) becomes
(3.13) E[e -~s(')] = exp { t [ l - ( 1 +z)P]}.
Recall the stable distribution of order fl that is concentrated on the positive axis
(FELLER, 1971, Sections XIII.6 and XI|I.7). Let gp(x) denote its probability
density function. Its Laplace transform is
O0
i o
e - ~" gp (x) dx = e - :'
For ,8 = 1/2, a closed form expression for the stable density is available,
Let {S(t)} be a gamma process with (at time t = 0) unknown parameters a and
b. We claim that, if we can observe the process for a time interval of
(arbitrarily short) length h, h > 0, the value of a can be obtained as a limit:
For 0 < x < l, we define the random variable
N(h; x)
(4.1) A(x) = - ;
h In (x)
RISK THEORY WITH THE GAMMA PROCESS 183
then
(4.2) lim A ( x ) = a.
x~O
(We remark that a similar situation exists for the diffusion process with a priori
unknown but constant infinitesmal drift p and variance O"2 ; I f the sample path
for an arbitrarily small time interval is known, O"2 c a n be calculated.)
To prove (4.2), we write (4.1) as
oo e - b Y d y
A(x) =
i x y g ( h ; x)
. a.
I ' dY ah I°°
x Y x Y
Applying L'H6pital's rule, we see that the first ratio tends to 1 as x tends to 0.
The second ratio is N(h; x)/[hQ(x)]; by the strong law of large numbers it
converges to l (with probability one) as x tends to 0.
In the following we assume that the value of a is known, but that b is
unknown. I f the aggregate claims process has been observed to time t, S ( t ) is a
sufficient statistic, i.e., any additional information about the sample path is
irrelevant for the estimation of b (DE GROOT, 1975, p. 304, #5). To illustrate
this, let us treat the unknown b as a random variable O with prior probability
density function u(O), O > 0. Then the posterior density o f O at time t, given
the value of S(t), is
0 a' e -°s(') u(O)
u(O; t) =
oo r ~' e -'s(') u(r) dr
i o
with fl > 0 and a > I. Then the posterior density is also g a m m a , with
parameters
O~t = o f + a t
and
fit = fl+ S ( t ) .
At time t = O, the expected aggregate claims per unit time are
E =a dO=a
o 0 ot-I
184 FRAN(~OIS
DUFRESNE, HANS U. GERBER AND ELIASS.W. SHIU
12
11
r--
/
10
:f-
7
3
/
0 1 2 3 4 5 6 7 8 9
FIGURE 1.
RISK THEORY WITH THE GAMMA PROCESS 185
parameter az/2 (DE GROOT, 1975, p. 244, #5). Thus, if we want to simulate a
sample path for S(t), 0 <_ t _< T, we can proceed as follows. First we simulate
a value for S ( T ) , whose distribution is gamma with shape parameter aT and
scale parameter b. Then we obtain S(T/2) by simulating a value for
S(T/2)/S(T), which has a symmetric beta distribution with parameter aT/2.
Next, we obtain S(T/4) and S(3 T/4) by simulating the values of S(T/4)/S(T/2)
and [S(3 T/4)-S(T/2)] / [ S ( T ) - S ( T / 2 ) ] , respectively, each of which has a
symmetric beta distribution with parameter aT/4. Similarly, we can generate
the values of S(T/8), S(3 T/8), S(5 T/8), S(7 T/8), and so on.
We have simulated the standardized gamma process for various T. A sample
path for T = l0 is shown in Figure I.
6. RUIN THEORY
We assume that 0 > 0. Let ~ (u) denote the probability of ultimate ruin, i.e.,
the probability that the surplus becomes negative at some future time.
In view of formula (2.4), results for this model can be obtained via those for
the compound Poisson model with the following recipe. We start with a
formula for the case of the compound Poisson process with Poisson parameter
2 and individual claim amount distribution P(y). Then we substitute Q(y)
for 211 - P ( y ) ] (or q(y) for 2 p ( y ) if the derivatives exist) to obtain the corre-
sponding formula for the more general model.
For example, in the compound Poisson model the probability of ruin
satisfies the following defective renewal equation [e.g., BOWERS et al. (1986,
p. 373, #12.11)]:
c~u(u) =
(6.3)
I ° ~(u-y)
0
Q(y) dy +
I u
Q(y) dy, u > O.
186 FRANCOIS DUFRESNE, HANS U. GERBER AND ELIAS S.W. SHIU
(6.4) ~(0) = - Q ( y ) dy = ~ .
c 0 1+0
Let us now consider the maximal loss random variable
(6.6) L = L i + L 2 + ... + L N.
Here N, L~, L2, ... are independent random variables, the Li's are identically
distributed with the probability density
1-P(x)
(6.7) h(x) = , x > O,
i o~ [ l - e ( y ) ]
0
dy
(6.8) P r ( N = n) - +O
0 (1-~ ) n =0,1,2,....
Q(x)
(6.9) h(x) - , x > O.
oo Q ( Y ) dy
i o
These formulas can be used to determine numerical lower and upper bounds
for the ruin probability; see Method 1 in DUFRESNE and GERBER (1989).
F o r the next result we assume that p ( x ) = P' (x) and q ( x ) = - Q ' (x) exist.
Let T d e n o t e the time of ruin. Put X = U ( T - ) , the surplus immediately before
ruin, and Y = IU(T)I, the deficit at the time of ruin. We assume that u = 0.
Given that ruin occurs, the joint probability density of X and Y in the
c o m p o u n d Poisson case is
p(x+y)
(6.10) h(x,y) = , x > O,y > 0
I ~
0
[1 - P ( s ) ] as
RISK THEORY WITH THE GAMMA PROCESS 187
(DUFRESNE and GERBER, 1988). Thus, in the general model, the joint density
of X and Y is
q(x+y)
(6.11) h(x,y) - , x > O , y > O.
i oo Q ( s ) ds
o
We note that both (6.10) and (6.11) are symmetric in x and y. The probability
density of Z = X + Y (the amount of the claim that cases ruin) is
I
~ Q ( s ) ds
o
g(z) z
oo
(6.16) C =
02
oo
S o
ydP ( y )
2
S
o
y e ny d P ( y ) - c
(6.17) C =
-0
oo
i o
ydQ(y)
-
i o
yeRYdQ(y)--c
or
oo e - y
(7.2) Q(x) =
i x
--
Y
dy.
i o
Q (x) dx =
i o
xq (x) dx =
i o
e - "~d x = 1,
(7.5) H(x) =
So
h ( y ) dy = l - e - ~ + x E l ( x ) , x > O.
RISK THEORY WITH THE GAMMA PROCESS 189
As in the last section we assume that the aggregate claims process is the
standardized gamma process. Since (7.5) gives an explicit expression for H ( x ) ,
we can apply the method of lower and upper bounds to calculate the
probability of ruin (DUFRESNE and GERBER, 1989). We have calculated lower
and upper bounds for ~ ( u ) for different values of the initial surplus u
(0, I, 2, ..., 20) and the relative security loading 0 (0.1, 0.2, 0.3 . . . . . 1.0), for
intervals of discretisation with length 0.01 and 0.001. For 0 = 0.5 these bounds
are displayed in Table 1. Thus the exact value of the probability of ruin is
known with sufficient accuracy (4 decimals). Table 2 shows these values.
TABLE 1
LOWER AND UPPER BOUNDS FOR THE PROBABILITYOF RUIN
0 = 0.5
I 0.001 __1
0.01
Solution: We assume that the premiums are received continuously and the
aggregate claims process can be modelled by a gamma process with parameters
a and b. Then a/b = / z = 100,000 and a/b 2 = a 2 = (20,000) 2. It follows that
b = ~fir 2 = 1/4,000. In order to use Table 2 (which is for the standardized
gamma process), we have to transform the initial reserve to
u = 48,000x b = 12. The relative security loading 0 = 0.2 does not change.
Looking up Table 2, we obtain the probability of ruin ~(12) = 0.018.
ACKNOWLEDGMENT
This paper was completed during the tenure of the senior author as the first
Dr. L . A . H . WARREN Professor o f Actuarial Science at the Faculty of
Management, University o f Manitoba. Support from the Warren Professorship
Endowment Fund and the Natural Sciences and Engineering Research Council
of Canada is gratefully acknowledged.
RISK THEORY WITH THE GAMMA PROCESS 191
TABLE 2
THE PROBABILITY OF RUIN FOR TIlE STANDARDIZED GAMMA PROCESS
Relative security loading 0
0 0.9091 0.8333 0.7692 0.7143 0.6667 0.6250 0.5882 0.5556 0.5263 0.5000
1 0.7395 0.5736 0.4613 0.3816 0.3229 0.2782 0.2434 0.2155 0.1929 0.1743
2 0.6184 0.4165 0.2990 0.2253 0.1764 0.1424 0.1178 0.0994 0.0854 0.0743
3 0.5182 0.3038 0.1952 0.1344 0.0977 0.0741 0.0582 0.0470 0.0388 0.0327
4 0.4345 0.2219 0.1277 0.0805 0.0544 0.0388 0.0289 0.0224 0.0178 0.0145
5 0.3643 0.1621 0.0836 0.0482 0.0303 0.0204 0.0144 0.0107 0.0082 0.0065
6 0.3054 0.1185 0.0548 0.0289 0.0169 0.0107 0.0072 0.0051' 0.0038 0.0029
7 0.2561 0.0866 0.0359 0.0173 0.0094 0.0056 0.0036 0.0025 0.0018 0.0013
8 0.2148 0.0632 0.0235 0.0104 0.0053 0.0030 0.0018 0.0012 0.0008 0.0006
9 0.1801 0.0462 0.0154 0.0062 0.0029 0.0016 0.0009 0.0006 0.0004 0.0003
10 0.1510 0.0338 0.0101 0.0037 0.0016 0.0008 0.0005 0.0003 0.0002 0.0001
11 0.1266 0.0247 0.0066 0.0022 0.0009 0.0004 0.0002 0.0001 0.0001 0.0001
12 0.1062 0.0180 0.0043 0.0013 0.0005 0.0002 0.0001 0.0001
13 0.0890 0.0132 0.0028 0.0008 0.0003 0.0001 0.0001
14 0.0746 0.0096 0.0019 0.0005 0.0002 0.0001
15 0.0626 0.0070 0.0012 0.0003 0.0001
16 0.0525 0.0051 0.0008 0.0002
17 0.0440 0.0038 0.0005 0.0001
18 0.0369 0.0027 0.0003 0.0001
19 0.0309 0.0020 0.0002
20 0.0259 0.0015 0.0001
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FRAN(~OIS DUFRESNE
Ecole d'Actuariat, Universit~ Laval, QuEbec GIK 7P4, Canada.
HANS U . GERBER
tEcole des H.E.C., Universitd de Lausanne, CH-IO15 Lausanne, Switzerland.
ELIAS S . W . SHIU
Department of Actuarial and Management Sciences, Faculty of Management,
University of Manitoba, Winnipeg, Manitoba R3T 2N2, Canada.