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Stochastic distortion and its transformed copula

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  • Lin, Feng
  • Peng, Liang
  • Xie, Jiehua
  • Yang, Jingping

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.

Suggested Citation

  • Lin, Feng & Peng, Liang & Xie, Jiehua & Yang, Jingping, 2018. "Stochastic distortion and its transformed copula," Insurance: Mathematics and Economics, Elsevier, vol. 79(C), pages 148-166.
    • Handle: RePEc:eee:insuma:v:79:y:2018:i:c:p:148-166
    DOI: 10.1016/j.insmatheco.2018.01.003
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