2005 Kazuhisa Matsuda All rights reserved.

Inverse Gaussian Distribution

Kazuhisa Matsuda Department of Economics The Graduate Center, The City University of New York, 365 Fifth Avenue, New York, NY 10016-4309 Email: maxmatsuda@maxmatsuda.com http://www.maxmatsuda.com/
March 2005 Abstract This paper presents the basic knowledge of the inverse Gaussian distribution.

2005 Kazuhisa Matsuda All rights reserved.

 2005 Kazuhisa Matsuda All rights reserved. [1] Inverse Gaussian Distribution: JKB (1994) Parameterization There are many different parameterizations of the inverse Gaussian distribution which can be really confusing to beginners. In this section, basic properties of the inverse Gaussian distribution is presented following Johnson, Kotz, and Balakrishnan (1994)s parameterization of the equation (15.4a). The probability density function of the inverse Gaussian distribution is a two parameter family:
IG ( z; , ) = 3/ 2 z exp 2 ( z ) 2 1x >0 , 2 2 z

(1)

where R + and R + . By Fourier transforming the IG probability density (1), its characteristic function Z ( ) is calculated as:

Z ( ) FZ [ IG ( z; , )]( ) ei z IG ( z )dz

Z ( ) = ei z IG ( z )dz = exp
0

2i 2 .

(2)

Simplifying the equation (2) yields:

2 2 2 Z ( ) = exp 1 2 2 2 2i 2 2i Z ( ) = exp 1 1 .

Z ( ) = exp

2 2 = 2 i exp 1 2 i 2 2

(3)

The characteristic exponent (i.e. cumulant generating function) Z ( ) of the IG distribution is:

Z ( ) ln Z ( ) =

2 2i 1 1

(4)

 2005 Kazuhisa Matsuda All rights reserved. 1 n Z ( ) i n n

Using (4), the first four cumulants defined by cumulantn ( Z ) calculated as the follows: cumulant1 = ,
cumulant2 = 3 / , cumulant3 = 3 5 / 2 , cumulant4 = 15 7 / 3 .

=0

are

Using the above cumulants, the mean, variance, skewness, and excess kurtosis of the IG random variable Z are obtained as (consult Table 4.1 of Matsuda (2004)):
E[ Z ] = ,

(5)
3

Variance[ Z ] = / ,

Skewness[ Z ] = 3 / , Excess Kurtosis[ Z ] = 15 / .

The moment generating function M Z ( ) of the IG distribution can be expressed as:

M Z ( ) = exp ( Z ( ) ) ,

M Z ( ) e z IG ( z; , )dz = e z IG ( z )dz
0

where the Laplace exponent Z ( ) is given by:

Z ( ) =

2 2 1 1

(6)

Using the moment generating function M Z ( ) with (6), first four raw moments (i.e. rn n M Z ( ) n
=0

) of the IG distribution are computed as: r1 E[ Z ] = , r2 E[ Z 2 ] = 2 +

3 , 3 4 3 5 r3 E[ Z 3 ] = 3 + + 2 , 5 6 15 6 15 7 4 4 r4 E[ Z ] = + + 2 + 3 .

 2005 Kazuhisa Matsuda All rights reserved.

Note that the form of centered moments of (5) tells us that the IG probability density is always positively skewed and the excess kurtosis is always positive. Figure 1 illustrates the shape of the IG distribution with varying parameters. In Panel A, as increases, its variance, skewness, and excess kurtosis decreases. In Panel B, as rises holding constant, all moments rise.

=0.1

Probability Density

2 1.5 1 0.5 0 0 0.5 1 z 1.5 2

=0.5 =1 =2 =4 =8 =16

A) = 1 and varying

=0.5

Probability Density

1.5

=1 =2

=4 =8

0.5

=16 =32

0 0 1 2 z 3 4 5

B) Varying and = 1 Figure 1 Plot of IG probability density

 2005 Kazuhisa Matsuda All rights reserved. Probably, the most important property of the IG distribution is its infinite divisibility. Let Z be an IG random variable with R + and R + . Then, there exist n pieces of i.i.d . random variable Z1 , Z 2 ,..., Z n each from the IG distribution with / n R + and

/ n R + such that:
Z d Z1 + Z 2 + ... + Z n ,

which is the definition 3.3 of Matsuda (2005). This indicates that the IG distribution generates a class of increasing Lvy processes (subordinators). [2] Inverse Gaussian Distribution: Barndorff-Nielsen (1998) Parameterization In this section, basic properties of the inverse Gaussian distribution is presented following Barndorff-Nielsen (1998)s parameterization. Reparameterize the IG probability density (1) using = / and = 2 :
IG ( z; , ) = 3/ 2 z exp 2 ( z ) 2 1x >0 2 2 z
2

2 3/ 2 2 IG ( z; , ) = z exp z 1x >0 2 2 2( / ) z
IG ( z; , ) =

2 2 z 3/ 2 exp z 2 2 z + 2 1x >0 2 2z

2z 2 z 3/ 2 exp + 1x >0 2z 2 2 ( 2 z 1 + 2 z ) 3/ 2 IG ( z; , ) = z exp 1x >0 , 2 2 IG ( z; , ) =

where R + and R + .

(7)

By Fourier transforming the IG probability density (7), its characteristic function Z ( ) is calculated as:

Z ( ) FZ [ IG ( z; , )]( ) ei z IG ( z )dz
0

Z ( ) = ei z IG ( z )dz = exp 2 2i .

(8)

 2005 Kazuhisa Matsuda All rights reserved. The characteristic exponent (i.e. cumulant generating function) Z ( ) of the IG distribution is:

Z ( ) ln Z ( ) = 2 2i .
Using (9), the first four cumulants defined by cumulantn ( Z ) calculated as the follows: cumulant1 = / ,
cumulant2 = / 3 , cumulant3 = 3 / 5 , cumulant4 = 15 / 7 .

(9) 1 n Z ( ) i n n are

=0

Using the above cumulants, the mean, variance, skewness, and excess kurtosis of the IG random variable Z are obtained as (consult Table 4.1 of Matsuda (2004)):
E[ Z ] = / ,

(10)
3

Variance[ Z ] = / , 3 Skewness[ Z ] = ,

Excess Kurtosis[ Z ] =

15

The moment generating function M Z ( ) of the IG distribution can be expressed as:

M Z ( ) = exp ( Z ( ) ) ,

M Z ( ) e z IG ( z; , )dz = e z IG ( z )dz
0

where the Laplace exponent Z ( ) is given by:

Z ( ) = 2 2 .

(11)

Using the moment generating function M Z ( ) with (11), first four raw moments (i.e. rn n M Z ( ) n
=0

) of the IG distribution are computed as: r1 E[ Z ] = / ,

 2005 Kazuhisa Matsuda All rights reserved. r2 E[ Z 2 ] =

(1 + ) , 3 (3 + 3 + 2 2 ) r3 E[ Z 3 ] = , 5 (15 + 15 + 6 2 2 + 3 3 ) r4 E[ Z 4 ] = . 7

Note that the form of centered moments of (10) tells us that the IG probability density is always positively skewed and the excess kurtosis is always positive. Figure 2 illustrates the shape of the IG distribution with varying parameters. In Panel A, as increases holding constant, all the standardized moments decrease. In Panel B, as rises holding constant, the mean and variance rise while the skewness and excess kurtosis fall.
10

=0.1 =0.5 =1

Probability Density

8 6 4 2 0 0 0.2 0.4 0.6 0.8 z 1 1.2 1.4

=2 =4 =6 =8

A) = 1 and varying

 2005 Kazuhisa Matsuda All rights reserved.

1.4

=0.1 =0.5 =1 =2 =4 =6 =8

Probability Density

1.2 1 0.8 0.6 0.4 0.2 0 0 2 4 z 6 8 10

B) Varying and = 1 Figure 2 Plot of IG probability density Probably, the most important property of the IG distribution is its infinite divisibility. Let Z be an IG random variable with R + and R + . Then, there exist n pieces of i.i.d . random variable Z1 , Z 2 ,..., Z n each from the IG distribution with / n R + and

/ n R + such that:
Z d Z1 + Z 2 + ... + Z n ,

which is the definition 3.3 of Matsuda (2005). This indicates that the IG distribution generates a class of increasing Lvy processes (subordinators).

 2005 Kazuhisa Matsuda All rights reserved.

References Barndorff-Nielsen, O. E., 1998, Processes of Normal Inverse Gaussian Type, Finance and Stochastics 2, 41-68. Johnson, N. L., Kotz, S., and Balakrishnan, N., 1994, Continuous Univariate Distributions, Volume 1, Second Edition, John Wiley & Sons. Matsuda, K., 2004, Introduction to Option Pricing with Fourier Transform: Option Pricing with Exponential Lvy Models, Working Paper, Graduate School and University Center of the City University of New York. Matsuda, K., 2005, Introduction to the Mathematics of Lvy Processes, Vol. 1 of Ph.D. thesis expected to be filed on May 2006, Graduate School and University Center of the City University of New York.