Copulas & Transforms: Enkelejd Hashorva

Copulas & Transforms
Enkelejd Hashorva
University of Lausanne
1
Copula: Definitions & Examples
Distribution & Quantile Transforms
Properties of Copulas
Archimedean Copula
Insurance Application
Appendix
2
Copula: Simple Df’s with Uniform Marginals
Definition. Copula C is a multivariate df with marginal df’s

which are uniformly distributed on (0, 1).
Questions:
I How many copulas do we have in the bivariate setup (case

d = 2)?
I Why are copulas important and popular?
I If a function C is given, how do we know that it is a copula?
3
Examples: FGM & Gumbel Copula
FGM Copula: For α ∈ [−1, 1] define
Cα (u1 , u2 ) = u1 u2 (1 + α(1 − u1 )(1 − u2 )), u1 , u2 ∈ [0, 1]
We have Cα (u, 1) = Cα (1, u) = u, u ∈ [0, 1].

Gumbel Copula: Given α ∈ [1, ∞) define
1/α
Cα (u1 , u2 ) = exp − (− ln u1 )α + (− ln u2 )α , u1 , u2 ∈ [0, 1]
Cα (u, 1) = Cα (1, u) = exp(ln u) = u, u ∈ [0, 1]
4
Example: Mixture Copula
If P, Q are two different copulas (d-dimensional), then for any

λ ∈ (0, 1) the mixture
Cλ (u ) = λP(u ) + (1 − λ)Q(u ), u ∈ [0, 1]d

is a copula since it is a df, and its ith marginal is given by
Cλ (1, . . . , 1, ui , 1, . . . , 1) = λui + (1 − λ)ui = ui , ui ∈ [0, 1]
for any i ≤ d.
5
Notes
6
A Function C is a Copula if ...
Definition: A function C : [0, 1]2 7→ [0, 1], then it is a copula if
P1. C is increasing in each component

P2. C (0, u) = C (u, 0) = 0, u ∈ [0, 1] and
C (1, u) = C (u, 1) = u, u ∈ [0, 1]
P3. [a1 , b1 ] × [a2 , b2 ] has a non-negative”C-volume” i.e.,
C (b1 , b2 ) − C (a1 , b2 ) − C (b1 , a2 ) + C (a1 , a2 ) ≥ 0
for any [a1 , b1 ] × [a2 , b2 ] ⊂ [0, 1]2 .
Under P1-P3 C is a bivariate df with uniform marginal df’s.
7
Example: Independence Copula

CI ( u ) = u = (u1, . . . , ud )
Q
i≤d ui , ui ∈ [0, 1], i ≤ d,
8
Example: Fréchet Copula or Upper Copula
CU (u ) = min ui , u ∈ [0, 1]d

i≤d
9
Example: Lower Copula (only for d = 2!)

d
CL (u ) = max u ∈ [0, 1]d
X
ui − (d − 1), 0 ,
i=1
10
Clayton Copula
For any α > 0 define a d-dimensional copula Cα by

d
Cα ( u ) = u ∈ [0, 1]d
X −1/α
ui−α − d + 1 ,
i=1
11
Example: Multivariate FGM Copula
Define a copula C by
C (u ) = 1 + u ∈ [0, 1]d
h X i Y
ρ(i, j)(1 − ui )(1 − uj ) ui ,
1≤i<j≤d 1≤i≤d
where the function ρ(·, ·) satisfies

X
1+ εi εj ρ(i, j) ≥ 0 (1)
1≤i<j≤d
with εi = ±1, 1 ≤ i ≤ d.
12
Distribution Transform
If X is a rv with continuous df F , then the rv F (X ) is uniformly

distributed on (0, 1), i.e.,
d
F (X ) = U ∼ Uniform(0, 1) (2)
For F not continuous see Appendix!
13
Bivariate Transform
Let (X1 , X2 ) ∼ F be a bivariate RV with a joint pdf f .

Define (U1 , U2 ) by
U1 = F1 (X1 ), U2 = F2 (X2 )
where F1 , F2 are the marginal df’s of F .

Since Fi ’s are continuous, then both U1 and U2 are uniformly
distributed on (0, 1)
but U1 and U2
are dependent rv’s
if X1 and X2 are dependent rv’s.
14
Rosenblatt Transform
The Rosenblatt transform is another bivariate transform of

(X1 , X2 ) ∼ F with a pdf f . It removes dependence!
Denote by F2|1 (·|x1 ) the df of X2 |X1 = x1 .
The rv’s U1 and U2∗ defined by
U1 = F1 (X1 ), U2∗ = F2|1 (X2 |X1 ) (3)
are independent.
Moreover, U1 , U2∗ are uniformly distributed on (0, 1).
15
Quantile Transform/Function
If F is a continuous and strictly increasing univariate df, then its

inverse function F −1 exists and is unique.
For general F we define F −1 the generalised inverse of F by
F −1 (q) = inf{x : F (x) ≥ q}, q ∈ (0, 1] (4)
and set
F −1 (0) = sup{x : F (x) = 0}
In statistical terminology F −1 is the quantile function (qf).
In insurance and finance F −1 is the Value-at-Risk (VaR).
16
Quantile Transform & Simulation
For any df F (even not continuous)

d
X = F −1 (U), U ∼ Uniform(0, 1) (5)
This suggests how to simulate X if we can simulate U,

leading to the inverse transform method.
Example: − ln U, − ln(1 − U) are unit exponential rv’s.
17
Properties of Quantile Function
I Important relation
F −1 (q) ≤ x ⇐⇒ q ≤ F (x), ∀q ∈ (0, 1) (6)
I Since F is right-continuous, meaning
lim F (s) = F (x), x ∈R

s↓x
then F −1 is left-continuous.
18
Simulation of Bivariate RV’s
Let (X1 , X2 ) ∼ F with a pdf f .

Step 1. Simulate u1 , u2∗ from two independent rv’s
U1 , U2∗ ∼ Uniform(0, 1)
Step 2. Determine the inverse function F1−1 (·)
−1
Step 3. Determine the inverse function F2|1 (·|x1 )
Step 4. Calculate
x1 = F1−1 (u1 ), −1 ∗
x2 = F2|1 (u2 |x1 )
19
Simulation of Bivariate RV’s with Uniform Marginals

Let (X1 , X2 ) with df C which is a copula with pdf c.
Step 1. Simulate u1 , u2∗ from two independent rv’s
U1 , U2∗ ∼ Uniform(0, 1)
−1
Step 2. Determine C2|1 (·|u1 ). We have
∂
C2|1 (u2 , u1 ) = P{X2 ≤ u2 |X1 ≤ u1 } = C (u1 , u2 )
∂u1
Find then the inverse of C2|1 .
Step 3. Calculate
x1 = F1−1 (u1 ) = u1 , −1 ∗
x2 = C2|1 (u2 |u1 )
20
d-dimensional Setup
If U is a d-dimensional RV with Ui ∼ Uniform(0, 1), i ≤ d,

then its df C is a copula.
If Fi , i ≤ d are univariate df’s, define a RV X trasnforming U as
follows
X = (F1−1(U1), . . . , Fd−1(Ud ))
The df of X is determined by C and F1 , . . . , Fd .
We refer to C as copula of X or the copula of the df F .
21
Copula + Marginal DF’s = New DF

Let C be a d-dimensional copula and let F1 , . . . , Fd be univariate
distributions. We have
F (x ) = C (F1 (x1 ), . . . , Fd (xd ))
is a df. Indeed, if U = (U1, . . . , Ud ) has df C , then the RV

X=

F1−1 (U1 ), . . . , Fd−1 (Ud )
has df F since using (6)
P{X ≤ x } = P{Fi−1 (Ui ) ≤ xi , i ≤ d}

= P{Ui ≤ Fi (xi ), i ≤ d} = C (F1 (x1 ), . . . , Fd (xd ))
Note that Fi−1 (Ui ) has df Fi , so F has marginal df’s F1 , . . . , Fd .

22
Sklar’s Theorem
Theorem. If X ∼ F is a d-dimensional RV with marginals
Fi , i ≤ d, then we can find a copula C such that
F (x ) = C (F1 (x1 ), . . . , Fd (xd )), xi ∈ [−∞, ∞], i ≤ d
If Fi ’s are continuous, then C is unique determined by
C (u1 , . . . , ud ) = F (F1−1 (u1 ), . . . , Fd−1 (ud )), u ∈ [0, 1]d (7)
and moreover
U = (F1(X1), . . . , Fd (X2)) ∼ C
We say that C is the copula of X , or the copula of F .
23
Clayton Copula: d = 2
For any α > 0 in the bivariate setup Clayton copula is given by
Cα (u1 , u2 ) = (u1−α + u2−α − 1)−1/α , u1 , u2 ∈ [0, 1]
A RV (X1 , X2 ) has copula Cα if

Y1 −1/α Y2 −1/α
X1 = 1 + , X2 = 1 + (8)
Z Z
where Y1 , Y2 , Z are independent, Y1 , Y2 are unit exponential, Z
has Gamma distribution with parameter 1/α, 1.
24
Gaussian Copula
Let Φ be the df of a N(0, 1) rv with qf Φ−1 .

Let (X1 , X2 ) be jointly Gaussian with df Φ2 (x1 , x2 ).
Suppose that Xi ’s are N(0, 1) rv’s with correlation ρ ∈ (−1, 1).
Since the marginal df’s are continuous, the copula Cρ of Φ2 is
unique. By (7) it is given as
Cρ (u1 , u2 ) = Φ2 (Φ−1 (u1 ), Φ−1 (u2 ))

Z Φ−1 (u1 ) Z Φ−1 (u2 ) 2 2
1 − x −2ρxy +y
= p e 2(1−ρ2 ) dxdy
−∞ −∞ 2π 1 − ρ2
We call Cρ Gaussian copula, determined only by ρ and Φ−1 .
25
Usefulness of Copulas
Recall that given a copula C we can construct multivariate df with

any marginal df’s! For instance, if G1 , G2 are univariate df’s, then
F (x1 , x2 ) = C (G1 (x1 ), G2 (x2 )), x1 , x2 ∈ R
is a bivariate df with marginal df’s
F1 (x1 ) = C (G1 (x1 ), 1) = G1 (x1 ), F2 (x2 ) = C (1, G2 (x2 )) = G2 (x2 )
Example: Cρ (G1 (x1 ), G2 (x2 )), x1 , x2 ∈ R is a df with Gaussian

dependence and marginal df’s G1 , G2 .
26
Pdf Plot: Gaussian Copula with Gamma Marginals
27
Pdf Plot: Clayton Copula with Gamma Marginals
28
Pdf Plot: Clayton Copula with Gaussian Marginals
29
Survival Copula
Given a copula C we define a new copula Ce by
Ce(u1 , u2 ) = u1 + u2 − 1 + C (1 − u1 , 1 − u2 ), u1 , u2 ∈ [0, 1]
Ce is called the survival copula.

If F1 , F2 are continuous and F has copula C , then
F (s, t) = F1 (s) + F2 (t) − 1 + F (s, t)

= Ce(F1 (s), F2 (t)), s, t ∈ R
30
Transformation Invariance
Often in actuarial practice data are transformed, applying for

instance logarithms or affine transforms.
A useful property of copulas is the invariance with respect to such
transforms.
Let (X1 , X2 ) be a bivariate RV with continuous marginal df’s,
copula C , and let g1 , g2 be two continuous functions.
I i). If g1 , g2 are non-decreasing, then (g1 (X1 ), g2 (X2 )) has also

the copula C
31
I ii). If g1 is non-decreasing, and g2 is non-increasing, then

(g1 (X1 ), g2 (X2 )) has copula
u1 − C (u1 , 1 − u2 )
I iii). When g1 , g2 are non-increasing,

then (g1 (X1 ), g2 (X2 )) has the survival copula Ce
Remark: i)-iii) hold if g1 , g2 are strictly monotone and thus the

additional assumptions that g1 , g2 are continuous is not needed.
32
Decomposition of pdf
Copula construction allows for some interesting representation of
pdf f of F . If f exists, then F (x1 , x2 ) = C (F1 (x1 ), F2 (x2 )) ⇒
f (x1 , x2 ) = f1 (x1 )f2 (x2 )c(F1 (x1 ), F2 (x2 )), x1 , x2 ∈ R (9)
with c(u, v ) the pdf of C defined by
∂2
c(u, v ) := C11 (u, v ) = C (u, v )
∂u∂v
So we have
f (a1 , a2 )
c(u1 , u2 ) = , a1 = F1−1 (u1 ), a2 = F2−1 (u2 )
f1 (a1 )f2 (a2 )
Note that c(u, v ) is not always a true pdf!

33
Example: Gaussian Copula
For the Gaussian copula Cρ , ρ ∈ (−1, 1) we have
1 a2 − 2ρa a + a2 a2 + a2
1 2
cρ (u1 , u2 ) = p exp − 1 2
exp 1 2
1 − ρ2 2(1 − ρ2 ) 2
with a1 = Φ−1 (u1 ), a2 = Φ−1 (u2 ) since
1 a2 − 2ρa a + a2
1 2
f (a1 , a2 ) = exp − 1 2
2(1 − ρ2 )
p
2π 1 − ρ2
1
fi (ai ) = √ exp(−ai2 /2), i = 1, 2
2π
34
Pdf Plot: Gaussian Copula (α := ρ ∈ (−1, 1))
35
Example: FGM Coupla

Let Cρ , ρ ∈ (−1, 1) be the FGM copula
Cρ (u1 , u2 ) = u1 u2 [1 + ρ(1 − u1 )(1 − u2 )], u1 , u2 ∈ [0, 1]
Its density function cρ is given by
cρ (u1 , u2 ) = 1 + ρ(1 − 2u1 )(1 − 2u2 )
If Fi , i = 1, 2 are univariate df’s with pdf fi , i = 1, 2, then
F (x1 , x2 ) = Cρ (F1 (x1 ), F2 (x2 ))
is a FGM df with pdf
f (x1 , x2 ) = f1 (x1 )f2 (x2 )cρ (F1 (x1 ), F2 (x2 ))
36
Archimedean Copula
Definition of Archimedean Copulas

Let ψ : (0, 1] 7→ [0, ∞) with ψ(1) = 0, and
ψ being strictly decreasing convex function, which means
ψ 0 (s) < 0, ψ 00 (s) > 0, s ∈ (0, 1]
If ψ(u1 ) + ψ(u2 ) ≤ ψ(0), u1 , u2 ∈ [0, 1], then define
Cψ (u1 , u2 ) = ψ −1 (ψ(u1 ) + ψ(u2 )), u1 , u2 ∈ [0, 1]
and set Cψ (u1 , u2 ) = 0, otherwise.

We shall call Cψ an Archimedean copula with (Archimedean)
generator ψ.
37
Archimedean Copula
Example: Independence Copula
The independence copula CI is a special case with ψ(x) = − ln(x),

since ψ −1 (y ) = exp(−y ) and
Cψ (u1 , u2 ) = ψ −1 (ψ(u1 ) + ψ(u2 ))

= exp(−[− ln u1 − ln u2 ])
= exp(ln(u1 u2 )) = u1 u2 , u1 , u2 ∈ [0, 1]
Also the converse is true, namely if Cψ is a product df, then
ψ(x) = −c ln(x), c >0
38
Archimedean Copula
Example: Lower & Upper Copulas

If ψ(x) = 1 − x, then ψ −1 (x) = 1 − x, so for u1 , u2 ∈ [0, 1]
Cψ (u1 , u2 ) = max(0, 1 − (1 − u1 + 1 − u2 ))
= max(0, u1 + u2 − 1) = CL (u1 , u2 )
Note that ψ is not strictly convex!

Is CU (u1 , u2 ) = min(u1 , u2 ) an Archimedean copula?
CU (u, u) = ψ −1 (ψ(u) + ψ(u)) = ψ −1 (2ψ(u)) = u

⇒ 2ψ(u) = ψ(u), u ∈ (0, 1)
⇒ ??
39
Archimedean Copula
Examples
I The Clayton copula for which
x −α − 1
ψα (x) = , α>0
α
I The Frank copula has generator ψα given by
e −αx − 1
ψα (x) = − ln −α , α=6 0
e −1
leading to copula
1 [e −αu1 − 1][e −αu2 − 1]
C (u1 , u2 ) = − ln 1 +
α e −α − 1
I The Gumbel copula with generator ψα given by
ψα (x) = (− ln x)α , α≥1
40
Archimedean Copula
Pdf Plot: Clayton Copula
41
Archimedean Copula
Pdf Plot: Frank Copula
42
Archimedean Copula
Conditional Independence: Frailty Model
Let (X1 , X2 ) be conditionally independent given Θ = θ, with

Θ ∼ Q, Θ > 0. Assume that for H1 , H2 two df’s and x ∈ R
P{Xi ≤ x|Θ = θ} = [Hi (x)]θ , θ > 0, i = 1, 2
If LΘ is the Laplace transform of Θ, since aΘ = e Θ ln a , a > 0
P{X1 ≤ x1 , X2 ≤ x2 } = LΘ (t), (10)
with t = − ln H1 (x1 ) − ln H2 (x2 ).
43
Archimedean Copula
Simulation of Frailty Model

Since X1 , X2 are independent given Θ = θ > 0, and they have df’s
Fi = Hiθ , then we have
d
Xi |(Θ = θ) = Fi−1 (Ui ) (11)
with U1 , U2 iid Uniform(0, 1) rv’s. The inverse Fi−1 can be

calculated explicitly, we have u = Fi (x) = Hiθ (x) or u 1/θ = Hi (x),
hence x = Hi−1 (u 1/θ ) is the inverse of Fi (x), consequently
1/θ
Fi−1 (Ui ) = Hi−1 (Ui ).
Simulation algorithm:
Step 1: Simulate θ from the df of Θ
Step 2: Simulate u1 , u2 from U1 , U2
1/θ
Step 3: Calculate x1 , x2 using xi = Hi−1 (ui ), i = 1, 2.
44
Archimedean Copula
Frailty Model & Archimedean Copula
Take ψ −1 (t) = LΘ (t), then we have
P{X1 ≤ x1 , X2 ≤ x2 } = ψ −1 (− ln H1 (x1 ) − ln H2 (x2 ))
If F1 , F2 are continuous (which follows if H1 , H2 are continuous),

then the copula C of (X1 , X2 ) is
C (u1 , u1 ) = ψ −1 (ψ(u1 ) + ψ(u2 ))
for ψ(u1 ) + ψ(u2 ) ≤ ψ(0), thus C is Archimedean with generator

ψ = L−1
Θ .
45
Archimedean Copula
Frailty Model in Survival Analysis
Let (X1 , X2 ) be conditionally independent given Θ = θ, with

Θ > 0. Assume that for i = 1, 2 and H1 , H2 two df’s
P{Xi > x|Θ = θ} = [H̄i (x)]θ , x ∈ R, θ > 0
Note that the univariate survival functions are modelled above.

Hence
P{X1 > x1 , X2 > x2 } = LΘ (t),
with t = − ln H̄1 (x1 ) − ln H̄2 (x2 ).
46
Archimedean Copula
Example: Frailty Model for Survival Analysis

If Θ is a Gamma rv with parameters α, λ, then for t > 0
Z ∞
λα λα t
LΘ (t) = e −tθ θα−1 e −λθ dθ = = (1 + )−α
Γ(α) 0 (λ + t)α λ
Hence, we have
ln H̄1 (x1 ) + ln H̄2 (x2 ) −α
P{X1 > x1 , X2 > x2 } = 1 −
λ
ln H̄i (xi ) −α
P{Xi > xi } = (1 − )
λ
A particular example is H̄i (s) = e −λs , hence α = 1, and
P{Xi > xi } = (1 + xi )−1 , P{X1 > x1 , X2 > x2 } = (1 + x1 + x2 )−1
47
Losses and Expenses
Losses and allocated loss adjustment expenses (ALAE) on a single

claim tend to be dependent rv’s.
Calculation of reinsurance premiums as a function of L losses and
A expenses requires modelling of the dependence between L and A.
48
Denuit et al. (2006) LOSS and ALAE Data
49
Scatter Plot
50
Bivariate Random Sample

Let (X1 , Y1 ), . . . , (Xm , Ym ) be RV’s. When these are iid, then we
refer to all of them as a bivariate random sample os size m.
If (X1 , Y1 ) has df F , we also refer to these random vectors as a
bivariate random sample with underlying df F .
If x1 , . . . , xm are observations from X1 , . . . , Xm and y1 , . . . , ym are
observations from Y1 , . . . , Ym , then we say that
(x1 , y1 ), . . . , (xm , ym )
are observations from the bivariate random sample
(X1 , Y1 ), . . . , (Xm , Ym )
51
Estimation of Marginal df’s
Given observations x1 , . . . , xm for losses

and y1 , . . . , ym for ALAE
we estimate the marginal df’s F1 , F2 by the sample versions, namely
1 X
F̂1 (s) = 1(xi ≤ s)
m
1≤i≤m
1 X
F̂2 (s) = 1(yi ≤ s)
m
1≤i≤m
with 1(·) the indicator function.
52
Pseudo-observations
The estimated marginals can be used to transform the observations

to lie on [0, 1]2 . So we define
x̂i = F̂1 (xi ), ŷi = F̂2 (yi ), 1≤i ≤m
We call (x̂i , ŷi ) pseudo-observations which are observations of

X̂i = F̂1 (Xi ), Ŷi = F̂2 (Yi ) with (X1 , Y1 ), . . . , (Xm , Ym ) a bivariate
random sample.
Since F̂1 and F̂2 depend on all observations, then
(X̂i , Ŷi ), i ≤ m is not a random sample, and therefore
(x̂i , ŷi ), i ≤ m are called pseudo-observations.
53
Likelihood
If f is the pdf of F , which is the underlying df of a bivariate
random sample (X1 , Y1 ), . . . , (Xm , Ym ), then given observations
(xi , yi ), 1 ≤ i ≤ m the likelihood is (recall (9))
m
Y m
Y
L(x1 , y1 , . . . , xm , ym ) = f (xi , yi ) = f1 (xi )f2 (yi )c(xi∗ , yi∗ )
i=1 i=1
with c the pdf of the copula C of F and xi∗ = F1 (xi ), yi∗ = F2 (yi ).
Hence the log-likelihood is
m
X m
X
`(x1 , y1 , . . . , xm , ym ) = ln f1 (xi ) + ln f2 (yi )
i=1 i=1
m
X
+ ln c(xi∗ , yi∗ )
i=1
54
Pseudo-log-likelihood
Define the pseudo-log-likelihood function
m
X
`P (x1 , y1 , . . . , xm , ym ) = ln c(F̂1 (xi ), F̂2 (yi ))
i=1
calculated by the pseudo-observations (ûi , v̂i ) = (F̂1 (xi ), F̂2 (yi ))

plugged-in in the pdf c.
In case that c depends on α, then we determine an estimator of α
by maximising
m
X
P
` (α; x1 , y1 , . . . , xm , ym ) = ln cα (F̂1 (xi ), F̂2 (yi ))
i=1
55
Likelihood Approach
We construct the pseudo-observations
ûi = F̂1 (xi ), v̂i = F̂2 (yi ), i = 1, . . . , m
and then calculate the pdf c for each i ≤ m as
c(F̂1 (xi ), F̂2 (yi )) = c(ûi , v̂i )
In some situations we may assume say one of the marginal df’s is

parametrised by some parameter, say
F1 (x) = F1 (θ; x)
and f1 (θ; x) is the corresponding pdf. Using ML estimation we

obtain an estimator θ̂ for the unknown parameter θ using only
observations from F1 .
56
Semi-Likelihood Approach
Hence, we construct the pseudo-log-likelihood function as

m
X
P
` (α; x1 , y1 , . . . , xm , ym ) = ln cα (F1 (θ̂; xi ), F̂2 (yi ))
i=1
Given the estimator θ̂ we estimate α by maximising the above with

respect to α.
In some cases also F2 can be assumed to come from some
parametric family of df’s.
Example: F has marginal df’s F1 and F2 which are exponential df’s
and copula (which is unique) is an FGM pcopula with parameter
α ∈ [−1, 1].
57
Full-Likelihood Approach
If the pdf f of F is parametrised by some parameter λ, then the

likelihood that is constructed from the observations (xi , yi ), i ≤ m
is
m
Y
L(λ; x1 , y1 , . . . , xm , ym ) = f (λ; xi , yi )
i=1
hence we can directly estimate λ be maximising say log-likelohood

function with respect to λ for fixed observations.
58
Pseudo-log-likelihood for Archimedean Copulas
If the copula is Archimedean with generator ψ and it has a true

pdf cψ , then we have that
φ00 (ψ(u1 ) + ψ(u2 ))

cψ (u1 , u2 ) = , u1 , u2 ∈ [0, 1] (12)
φ0 (ψ(u1 ))φ0 (ψ(u2 ))
with φ := ψ −1 .
Usually ψ depends on some parameter α for instance for Gumbel,
Clayton and Frank case.
Hence we estimate α using pseudo-likelihood approach and (12).
59
Non-parametric Approach
Let (Xi , Yi ), i ≤ n be a bivariate random sample of size m with
underlying df F and let (xi , yi ), i ≤ n be observations. The df F
can be estimated non-parametrically by
m
X
F̂ (s, t) = I(Xi ≤ s, Yi ≤ t)
i=1
and thus for given observations we have the estimated value

m
X
F̂ (s, t) = I(xi ≤ s, yi ≤ t)
i=1
If we want to estimate the copula C of F we do not have

observations, why?
60
In the absence of observations, we can still derive

pseudo-observations and pseudo random sample.
Namely, we have the pseudo random sample Ub1j = Fb1 (Xj ) and
Ub2j = Fb2 (Yj ), j ≤ m, with Fb1 and Fb2 non-parametric estimators of
the df of X1 and Y1 , respectively.
The pseudo observations are
ub1j = Fb1 (xj ), ub2j = Fb2 (yj ), j ≤ m
Since copula is also a df, we can estimate it non-parametrically

from the pseudo-observations as follows
m
1X
Cbm (u1 , u2 ) = u1j ≤ u1 )I(b
I(b u2j ≤ u2 ) (13)
n
j=1
61
Modelling with Archimedean Copulas
Large families of copulas with one parameter say α are the

Archimedean ones. For the data of losses and ALAE the estimators
reported in Denuit et al. (2006) are
for the Clayton copula: α̂ = 0.5174
for the Gumbel copula: α̂ = 1.4454
for the Frank copula: α̂ = 3.0861
The triple Cα̂ , F̂1 , F̂2 can be used for actuarial calculations.
62
Appendix
General Distribution Transform
Given a rv X ∼ F and a rv O ∼ Uniform(0, 1) define
U ∗ = F (X −) + O(F (X ) − F (X −))
which is another random variable.

When F is continuous, then U ∗ ∼ Uniform(0, 1).
Even when F is not continuous
d
U ∗ ∼ Uniform(0, 1), and thus F −1 (U ∗ ) = X (14)
63
Appendix
The Inverse Rosenblatt Transform
d
If U1 ∼ Uniform(0, 1), then F1−1 (U1 ) = X1 .
For U2∗ ∼ Uniform(0, 1) independent of U1 , and df F
with a joint pdf f and marginal df’s F1 , F2 , then

d
F1−1 (U1 ), F2|1
−1
(U2∗ |U1 ) = (X1 , X2 ) ∼ F
The above transformation can be regarded as the inverse of

Rosenblatt transform.
64
Appendix
Proof
Consider case d = 2. We verify that X1 ∼ F1 is independent of

U2 = F2|1 (X2 |X1 ) which implies that U1 is independent of U2
(why?). We show further that U2 ∼ Uniform(0, 1).
If F ∗ a continuous univariate df and U ∼ Uniform(0, 1),
then Fubini Theorem implies
Z
I (F ∗ (s) ≤ u) dF ∗ (s) = P{U ≤ u}, u ∈ [0, 1]
65
Appendix
If F1 is the df of X1 for any x ∈ R, u ∈ [0, 1]
P{X1 ≤ x, U2 ≤ u}
Z
= I (s ≤ x)I (y ≤ u) dF (s, y )
Z Z
= I (s ≤ x) I (F2|1 (y |s) ≤ u) dF2|1 (y |s)) dF1 (s)
Z Z
= I (s ≤ x) dF1 (s) I (F ∗ (y ) ≤ u) dF ∗ (y )
= P{X1 ≤ x}P{U ≤ u}
Hence U2 is independent of X1 and U2 = U ∼ Uniform(0, 1).
66
Appendix
Copula Definition
A d-dimensional function C is a copula if
P1. C is increasing in each component and

C (u1 , . . . , uk−1 , 0, uk+1 , . . . , ud ) = 0 for all
ui ∈ [0, 1], i 6= k, k ≤ d
P2. C (1, . . . , 1, ui , 1, . . . , 1) = ui for all ui ∈ [0, 1], i ≤ d
P3. For any ai ≤ bi , ai , bi ∈ [0, 1], i ≤ d
2
X 2
X
··· (−1)i1 +···+id C (x1,i1 , . . . , xd,id ) ≥ 0
i1 =1 id =1
with xk,1 = ak , xk,2 = bk , k ≤ d.
67
Appendix
Conditional Distributions & Copula

Assume that X ∼ F has continuous marginal df’s.
If C is the copula of X , then for any x1 , x2
P{X2 ≤ x2 |X1 = x1 } = C1,0 (F1 (x1 ), F2 (x2 ))
with
∂ ∂
C1,0 (u, v ) = C (u, v ), C0,1 (u, v ) = C (u, v )
∂u ∂v
In fact C1,0 (u, v ) exists almost everywhere for v ∈ [0, 1]
0 ≤ C1,0 (u, v ) ≤ 1 (15)
and is non-decreasing (almost surely) on [0, 1].
68
Appendix
Conditional df of Archimedean Copula
If ψ is the density generator of a bivariate Archimedean copula C ,

then the df F with copula Cψ has conditional marginal df given by
ψ 0 (F1 (x1 ))
P{X2 ≤ x2 |X1 = x1 } = (16)
ψ 0 (Cψ (F1 (x1 ), F2 (x2 )))
since
∂ ψ 0 (u1 )
Cψ (u1 , u2 ) = 0
∂u1 ψ (Cψ (u1 , u2 ))
69
Appendix
Decomposition of Copulas
Copulas as multivariate df’s might have singular components.

Although c(u1 , u2 ) exists almost everywhere (since C1,0 (u, v ) is
almost surely non-decreasing), it is not necessarily a pdf.
Example:
a) CL (u1 , u2 ) has cL (u1 , u2 ) = 0 almost surely on [0, 1]2 .
b) CU (u1 , u2 ) has cU (u1 , u2 ) = 0 almost surely on [0, 1]2 .
Question. What does almost surely above refer to?
70
Appendix
Every copula can be decomposed into singular

and absolutely continuous part, so we write
C (u1 , u2 ) = SC (u1 , u2 ) + AC (u1 , u2 )
with Z u1 Z u2
AC (u1 , u2 ) = c(x1 , x2 ) dx1 dx2
0 0
Example: The independence copula CI has only an absolutely
continuous part.
71
Appendix
Singular Part of Archimedean Copula

An Archimedean copula Cψ with generator ψ has a singular part
if and only if
ψ(0)
− >0 (17)
ψ 0 (0)
If Eq. (17) holds and (U1 , U2 ) ∼ Cψ , then
P{ψ(U1 ) + ψ(U2 ) = 0} = −ψ(0)/ψ 0 (0) > 0
Example: Clayton copula has no singular part since
ψ(x) x −α − 1
lim = lim =0
x→0 ψ 0 (x) x→0 αx −α−1
72
Appendix
Proof of (10)
Z ∞
P{X1 ≤ x1 , X2 ≤ x2 } = P{X1 ≤ x1 , X2 ≤ x2 |Θ = θ}dQ(θ)
0
Z ∞
= [H1 (x1 )H2 (x2 )]θ dQ(θ)
0
= E{e Θ ln(H1 (x1 )H2 (x2 )) } = E{e −tΘ }
= LΘ (t),
with t = − ln H1 (x1 ) − ln H2 (x2 ).
73
Appendix
Second Derivation of (10)
P{X1 ≤ x1 , X2 ≤ x2 } = E{1(X1 ≤ x1 , X2 ≤ x2 )}
= E{E{1(X1 ≤ x1 , X2 ≤ x2 )|Θ}}
= E{E{1(X1 ≤ x1 |Θ}E{1(X2 ≤ x2 |Θ}}
= E{[H1 (x1 )H2 (x2 )]Θ }
= E{e Θ ln(H1 (x1 )H2 (x2 )) } = E{e −tΘ }
= LΘ (t), t = − ln H1 (x1 ) − ln H2 (x2 )
74
Appendix
Proof of (12)
P{X1 > x1 , X2 > x2 } = E{1(X1 > x1 , X2 > x2 )}

= E{E{1(X1 > x1 , X2 > x2 )|Θ}}
= E{[H̄1 (x1 )H̄2 (x2 )]Θ }
= E{e −tΘ }, t = − ln H̄1 (x1 ) − ln H̄2 (x2 )
= LΘ (t)
75
Appendix
Frailty Model & Archimedean Copula: Derivations

For the frailty model define ψ −1 (t) = LΘ (t), so that we have
P{X1 ≤ x1 , X2 ≤ x2 } = ψ −1 (− ln H1 (x1 ) − ln H2 (x2 ))
Letting xi → ∞ for i = 1, 2 we have
ui = Fi (xi ) = LΘ (− ln Hi (xi )) ⇔ ψ(ui ) = − ln Hi (xi )
hence Hi (xi ) = e −ψ(ui ) and thus assuming that Hi is strictly

increasing we have Fi−1 (ui ) = Hi−1 (e −ψ(ui ) ), i = 1, 2.
If F1 , F2 are continuous (which follows if H1 , H2 are continuous),
then the copula C of (X1 , X2 ) is
C (u1 , u1 ) = F (F1−1 (u1 ), F2−1 (u2 )) = ψ −1 (ψ(u1 ) + ψ(u2 ))
thus C is Archimedean with generator ψ = L−1

Θ .
76

Copulas & Transforms: Enkelejd Hashorva

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Copulas & Transforms

Copulas & Transforms

Copula: Definitions & Examples

Distribution & Quantile Transforms

Copula: Simple Df’s with Uniform Marginals

Definition. Copula C is a multivariate df with marginal df’s

I How many copulas do we have in the bivariate setup (case

Examples: FGM & Gumbel Copula

FGM Copula: For α ∈ [−1, 1] define

Cα (u1 , u2 ) = u1 u2 (1 + α(1 − u1 )(1 − u2 )), u1 , u2 ∈ [0, 1]

We have Cα (u, 1) = Cα (1, u) = u, u ∈ [0, 1].

Cα (u, 1) = Cα (1, u) = exp(ln u) = u, u ∈ [0, 1]

Example: Mixture Copula

If P, Q are two different copulas (d-dimensional), then for any

Cλ (u ) = λP(u ) + (1 − λ)Q(u ), u ∈ [0, 1]d

Cλ (1, . . . , 1, ui , 1, . . . , 1) = λui + (1 − λ)ui = ui , ui ∈ [0, 1]

A Function C is a Copula if ...

Definition: A function C : [0, 1]2 7→ [0, 1], then it is a copula if

P1. C is increasing in each component

C (b1 , b2 ) − C (a1 , b2 ) − C (b1 , a2 ) + C (a1 , a2 ) ≥ 0

for any [a1 , b1 ] × [a2 , b2 ] ⊂ [0, 1]2 .

Under P1-P3 C is a bivariate df with uniform marginal df’s.

Example: Independence Copula

Example: Fréchet Copula or Upper Copula

CU (u ) = min ui , u ∈ [0, 1]d

Example: Lower Copula (only for d = 2!)

For any α > 0 define a d-dimensional copula Cα by

Example: Multivariate FGM Copula

where the function ρ(·, ·) satisfies

If X is a rv with continuous df F , then the rv F (X ) is uniformly

For F not continuous see Appendix!

Let (X1 , X2 ) ∼ F be a bivariate RV with a joint pdf f .

where F1 , F2 are the marginal df’s of F .

The Rosenblatt transform is another bivariate transform of

U1 = F1 (X1 ), U2∗ = F2|1 (X2 |X1 ) (3)

If F is a continuous and strictly increasing univariate df, then its

F −1 (q) = inf{x : F (x) ≥ q}, q ∈ (0, 1] (4)

Quantile Transform & Simulation

For any df F (even not continuous)

This suggests how to simulate X if we can simulate U,

Properties of Quantile Function

F −1 (q) ≤ x ⇐⇒ q ≤ F (x), ∀q ∈ (0, 1) (6)

I Since F is right-continuous, meaning

lim F (s) = F (x), x ∈R

Simulation of Bivariate RV’s

Let (X1 , X2 ) ∼ F with a pdf f .

Simulation of Bivariate RV’s with Uniform Marginals

If U is a d-dimensional RV with Ui ∼ Uniform(0, 1), i ≤ d,

Copula + Marginal DF’s = New DF

F (x ) = C (F1 (x1 ), . . . , Fd (xd ))

is a df. Indeed, if U = (U1, . . . , Ud ) has df C , then the RV

has df F since using (6)

P{X ≤ x } = P{Fi−1 (Ui ) ≤ xi , i ≤ d}

Note that Fi−1 (Ui ) has df Fi , so F has marginal df’s F1 , . . . , Fd .

F (x ) = C (F1 (x1 ), . . . , Fd (xd )), xi ∈ [−∞, ∞], i ≤ d

If Fi ’s are continuous, then C is unique determined by

C (u1 , . . . , ud ) = F (F1−1 (u1 ), . . . , Fd−1 (ud )), u ∈ [0, 1]d (7)

For any α > 0 in the bivariate setup Clayton copula is given by

Cα (u1 , u2 ) = (u1−α + u2−α − 1)−1/α , u1 , u2 ∈ [0, 1]

A RV (X1 , X2 ) has copula Cα if

Let Φ be the df of a N(0, 1) rv with qf Φ−1 .

Cρ (u1 , u2 ) = Φ2 (Φ−1 (u1 ), Φ−1 (u2 ))