Stochastic distortion and its transformed copula

Feng Lin, Liang Peng, Jiehua Xie and Jingping Yang

Insurance: Mathematics and Economics, 2018, vol. 79, issue C, 148-166

Abstract: Motivated by wide applications of distortion functions and copulas in insurance and finance, this paper generalizes the notion of a deterministic distortion function to a stochastic distortion, i.e., a random process, and employs the defined stochastic distortion to construct a so-called transformed copula by stochastic distortions. One method for constructing stochastic distortions is provided with a focus on using time-changed processes. After giving some families of the transformed copulas by stochastic distortions, a particular class of transformed copulas is applied to a portfolio credit risk model, where a numeric study shows the advantage of using the transformed copulas over the conventional Gaussian copula and the double t copula in terms of the fitting accuracy and the ability of catching tail dependence.

Keywords: Stochastic distortion; Transformed copula by stochastic distortions; Time-changed process; Portfolio credit risk model; Distortion function; Copula function (search for similar items in EconPapers)
Date: 2018
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Citations: View citations in EconPapers (5)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:insuma:v:79:y:2018:i:c:p:148-166

DOI: 10.1016/j.insmatheco.2018.01.003

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