RISK Linz

1
Vladimir Rykov
ELEMENTS OF GENERAL RISK THEORY
LINZ University
Linz, December 4-22, 2006
c _V.Rykov, 2006
Linz, 2006
2
OUTLINE
INTRODUCTION
Chapter I. BACKGROUND
1. Risk notion
2. Risk measurement
3. Some classes of r.v.s and operations with them
3
Chapter II. INDIVIDUAL RISK MODELS (ENGINEERING RISK
THEORY)
4. Methodology for risk analysis
5. Some parametric families of risk distributions
6. Compound distributions
7. Structural reliability
8. Qualitative analysis
4
Chapter III. COLLECTIVE RISK THEORY (INSURANCE RISK
THEORY)
9. The main notions and the problems formulation
10. Ruin problem for simple random walk model.
11. Classic ruin problem
12. Sparre Andersen model
13. The ruin problem for heavy-tailed claim distributions
Bibliography
[1] Andersen E. Sparre. On the collective theory of risk in case of
contagion between the ckaims. Trans. XV International Congress
of Actuaries, II-1957, pp. 219-229.
[2] Asmusssen S. Ruin probabilities. World Scientic, 1996.
[3] Barlow R.E. Engineering Reliability. Philadelphia: Society of
Industrial and Applied Mathematics, 1998.
[4] Bowers N. L. Jr., Gerber H. U., Hickman J. C., Jones D.
A., Nesbitt C. J. Actuarial Mathematics. Publ. by The Society
of Actuaries, 1986.
[5] Cramer H. On the mathematical risk theory. Skandia Jubilee
Volume, Stockholm, 1930.
[6] Cramer H. Collective risk theory. Skandia Jubilee Volume,
Stockholm, 1955.
BIBLIOGRAPHY 6
[7] Chukova, S. and Dimitrov, B. (1992) On distributions
having the almost lack of memory property.// Journal of Applied
Probability, 29(3), 691698.
[8] Chukova, S., Dimitrov, B., and Khalil, Z. (1993) A charac-
terization of probability distributions similar to the exponential.//
The Canadian Journal of Statistics, 21(3), 269276.
[9] Dimitrov, B. and Khalil, Z. (1992) A class of new probability
distributions for modeling environmental evolution with periodic
behavior.// Environmetrics, 3(4), 447464.
[10] Dayken C., Pentikainen T., Pesonen M. Practical Risk
Theory.
BIBLIOGRAPHY 7
[11] Feller W. Introduction in Probability Theory.
[12] Gertsbakh I. Reliability Theory with applications to Pre-
ventive Maintenance. Springer, 2000.
[13] Grandell Jan. Aspects of Risk Theory. Springer-Verlag.
N-Y, Brl, Lnd., 1991.
[14] Henley E.J., H Kumamoto H. Reliability engineering and
risk assessment. Prince-Hall Inc. Englewood Clis, N.J. 07632
[15] Henley E.J., H.Kumamoto H. Probabilistic Risk Assess-
ment. Reliability Engineering, Deign and Analysis. IEEE Press,
NY, 1992, 568p.
BIBLIOGRAPHY 8
[16] Kalashnikov V.V., Konstandinidis D. Ruin probabil-
ity. Review in Applied and Industrial Mathemetics. (In Russian).
[17] Lundbrg F.I. Approximerad Framstallnung av Sannolikhests-
funktionen, II. Aterforsaakrung av Kollektivisker.// Upsala:
Almqvist& Wiksel, 1903.
[18] Neumann J. von, Morgenstern O. Theory of games and
economic behavior. Princeton Univ.Press, 1953.
[19] Rolsky T., Schmidli H., Schmidt V., Teugels J.
Stochastic Processes for Insurance and Finance. J.Wiley&Sons,
1998.
BIBLIOGRAPHY 9
[20] Rotar V.I., Bening V.E. Introduction into mathematical
insurance theory.
Review in Applied and Industrial Mathemetics. V.1, No. 5 (1994),
pp. 698-779 (in Russian).
[21] V.V. Rykov, M.A. Yastrebenetsky. Risk: notion and
measurement.// In: Proceedings of the International Conference
Probabilistic Analysis of Rare Events: Theory and Problems of
Safety, Insurance and Ruin. Riga Avion University, 1999, 63-70.
[22] Rykov V. Reliability of technical systems and technogeneous
risk. Russian State Oil&Gas University, Moscow, 2001. (In
Russian).
[23] Solojentsev E.D. Scenario, logic and probabilistic management
of risk in business and engineering. Publishing house Business-
Pressa. Saint-Petersburg, 2006. 537pp.
BIBLIOGRAPHY 10
INTRODUCTION
During last years the term RISK became very popular in dierent
arias: engineering, economics, environment, management, biology &
medicine, etc. and dierent authors use this term in dierent senses.
Below we consider some denitions of risk in dierent sources.
Dictionaries.
[Webster dictionary:] Risk is chance of losses, probability of losses
[Ushakov dictionary:] Risk is possible dangerous, possible loss
(damage) or non-success in business.
International documents.
[INSAG-12]: Risk R(t) for time t, connected with some event, is
dened as a product of the probability of this event by non-wished
consequence D of this event: R(t) = P(t)D
[IEC 61508-4, Functional safety of electrical/ekectronic/programmable
electronic-related systems. Part 4. Denitions and abbreviations]:
3.1.5. Risk is combination of the probability of occurrence of
harm and the severity of that harm.
BIBLIOGRAPHY 11
National laws.
[RF, No.184-FL ]: Risk is a probability of harm causing for life
or healthy of citizens, property of physical or juristical persons, states
or municipal property, environmental, life or healthy of animals and
plants with taking into account the size of this harm
[RF, No.7-FL ]: Ecological risk is a probability of events occur-
rence, that has some bad consequences for environment and caused by
negative inuence of economical or other activity, extraordinary situa-
tions of natural and technogeneous character.
[Ukraine]: Risk is a possibility of occurrence and a probable scale
of consequences from negative phenomenon during some time period.
Normative documents.
[State standard 51897 ] - Risk management. Terms and denitions:
Risk is a combination of probability of event and its conse-
quences.
[State standard 51898 ] - Aspects of safety: Risk is a combination
of harm probability and its heaviness.
[ANSI/IEEE Std 352-1987 ] - An American National Standard.
IEEE Guide for General Principles of Reliability Analusis of Nuclear
Power Generation Station Safety Systems: Risk is a measure of the
probability and severity of undesired eects. Often taken as the simple
product of probability and consequence.
BIBLIOGRAPHY 12
Authors.
Gordon B.G. [News of State Nuclear Supervision - Vestnik Gosatom-
nadzor Rossia, 2003, No.1(25)]: Risk R is the product of proba-
bility of event P by the value of its consequences V : R = PV .
Alpeev A. [Reliability, 2005, No.1 ]: Risk is an evaluation of
expected damage from possible event in given conditions.
Emov S.L. [The encyclopedic dictionary. Economy and insurance.
Tcerikh-PEL, Moscow, 1996]: Risk is
1) a danger of a negative event...... Risk is characterized by a
collection of circumstances in their unity and interaction,
2) an object of insurance,
3) a kind of responsibility of the insurer.
[Commercial insurance in gas industry. Methodical recommenda-
tions for use in practical activity. Russian Join-stock Society Gasprom.
Moscow, 1998]: A wide spectrum of ... circumstances, not depen-
dent from will of the owner, having a property of probability, and
unexpectedness of appearance, are called as risk of economic activity
of the subject.
Grandel J. [Aspects of risk theory]: there is no denition of risk
at all, only descriptions of some risk models.
BIBLIOGRAPHY 13
Thus, the situation in this area now looks like a situation in reliability
theory a half a century ago, when dierent specialists use the term
reliability in dierent senses and mean under reliability dierent its
characteristics. It was needed a long time before it was understood
that the notion of reliability concerns a complex property of an
object, that are characterized with many dierent parameters.
Historically among of engineers the notion risk arisen in framework
of reliability theory and means the losses or damages for peoples,
environment and nance, Heynly&Kumamoto, 1992 [15].
From another side, among actuaries and mathematicians this term
is used in the framework of ruin models, Cramer, 1930, 1955 [5, 6],
Grandel, 1991 [12], and others.
There is one more conception of risk due to von Niemann and Mor-
genstern [18] which use utility theory for comparison of r.v.
BIBLIOGRAPHY 14
Therefore, now there exist at least three dierent risk theories:
Engineering risk theory, which deals with investigation of the con-
sequences (damages), generated with failures of complex non-reliable
systems;
Insurance risk theory, which deals with the ruin problems;
Business risk theory, which considers the problems of r.v. compari-
son in framework of utility theory.
In this situation the strong and common for dierent cases notion of
risk, that could be used in inter-disciplinary connections, and the
methods for the risk measurement and assessment are needed.
BIBLIOGRAPHY 15
The whole course contains three parts.
The general notions and denitions in the I chapter (1-3) are
considered.
1. The notion of risk is analyzed in 1.
2. The measurement of risk in 2 is proposed
3. The general properties of non-negative r.v.s in 3 are given.
The problems of engineering risks in the II chapter are investigated.
1. A general methodology for risk analysis is proposed in 4.
2. The problems of simple and compound individual risk modelling
in 5-6 are considered.
The III chapter deals with the insurance risks and the ruin problem.
We do non touch in this course the problems of risks comparison.
Chapter 1.
BACKGROUND
1. Risk notion
Dierent kinds of risks pursue both individuals during whole his
life and juridical subjects: industrial, agricultural plants, nancial, in-
surance companies, societies, political communities, biological objects,
ecological structures etc.
Most of economical, technical, political social and others decisions
connected with risk, that is inevitably arise due to randomness and
uncertainty of factors inuencing to the phenomenon to which the de-
cision is taken.
Habitual idea about risk means an occurrence some random risk
events, and its consequence such as nancial, material or others loses.
To separate a common component and dierences in dierent situa-
tions, which in habitual life are joint as risks situations, to show the
problems of general risk theory, and to formulate the goal and mean
notions of general risk theory, consider several examples.
CHAPTER 1. BACKGROUND 17
1.1. Examples
1.1.1. Risk of the health lost
Crossing the street in the ice time one has a risk to fall and twist a
leg or to get another injury. Here risk arise as a random event, and its
consequence is the cost of treatment, or missing reward.
1.1.2. Risk of work ability lost
Some types of professions contains the risks of lost of able to work
before the retire time as a result of professional illness. Another type
of work non-ability risks arise as a result of technological or social
changing in the community. It is obvious that the able-bodied lost also
leads to the nancial and moral loses.
1.1.3. Property missing risks
Driving one has a risk of accidence. Opening new business one has a
risk to loss the money, if it is not going well. Some person or a factory
risk with its wealthy in the case of re, storm, earthquake etc. These
phenomenons are also distributed in time and also brings some loses.
1.1.4. Social risks
Because there are something to lose for the owners, they need to
spend some money for the life, health, property etc. defence.
Nevertheless, the adequate social organization of community might
be more direct and reliable way for defence of the interests of dierent
layers of society.
The problem what this organization should be is not the question
for this course. Another example of social risks are medical risks.
1.1.5. Medical risks
For surgical operation we are risking with some disability and even
the life in more degree with less experienced surgeon. Nevertheless,
as a Russian writer and physician V.Veresaev noted, that because the
experience comes only with practice, thus if nobody will use the young
surgeons, the whole community risks to lost the professional surgeons.
This example shows a contradiction between an individual and social
risks.
1.1.6. Financial and business risks
The play at a stock-market also as any nancial operation associated
with risks.
1.1.7. Natural, ecological and technogeneous risks
The nature itself from one side and the humans activity from the
other side are sources of risks. The avoidances on large chemical enter-
prizes, breaks in oil- and gas- pipelines etc. represent signicant haz-
ard and lead to high damage for population and environment. Since
these risks are connected with reliability of appropriate equipment,
their study directed to excuse the payment for the providing and sup-
port of the necessary level of reliability equipment.
1.1.8. Insurance of risks and risk of insurance
Using the idea of risks accumulation (collectivization) the insurance
serves to stabilization of economics by means of smoothing of the risks
consequences. From another side an insurance itself is a source of risks,
which is connected with claims payment. More about insurance risks
will be done later.
The most of examples above deals with separate (individual) risks.
But it is necessary to take into account that many of above examples
(especially in insurance problems) risk situations can be repeated in
time that leads to the necessity to study so called collective risks.
The variety of these examples demonstrate the diculties in general
risk theory construction. To do that one should separate the common
part of all considered (and many others) situations, to formulate the
notion of risk and to propose the measure and the tools for measuring
and comparison of risks.
The linguistic analysis of the examples above shows that in any risk
situation the experts deal with
NEGATIVE
CHANGES
of STATE
of
an
OBJECT
under
inner
or
exter
nal
AFFECTS
or
CIRCUM-
STANCES
This analysis justies the following substantial denition
Denition 1.1. A risk is an event or sequence of events
which leads to negative changes in state of an object under inner or
external aects or circumstances.
This denition allows us to propose some general mathematical
approach to model any risk situation.
1.2. Notion of risk
In all of these examples risk is connected with occurrence some
random or uncertain event A, which is called risk event
from the family T of events, describing considered risk situation,
and it is characterized by two r.v:
the time up to the event occurs (T), and
the size of damage (X).
From mathematical points of view the situation could be considered
with dierent methods:
probabilistic,
subjective (by methods of subjective probabilities),
expert (by utility theory methods),
by the fuzzy sets technique, etc.
In the following we limited ourselves only by probabilistic aspects
and methods of risks study.
From this point of view the risk should be described as a probabilistic
space (, T, P) on which a two-dimensional r.v. (T, X), or a sequence
of two-dimensional r.v.s (T
n
, X
n
, n = 0, 1, . . . ) are determined.
Denition 2.1. A risk is a two-component r.v. (T, X), or a
sequence of two-components r.v.s (T
n
, X
n
, n = 0, 1, . . . ) (a marked
point process), dened under some probabilistic space (, T, P).
Remark. The second component X might be a multi-dimensional
one or even functional. Therefore, the term random element would
be more appropriate, but we will use the rst more usual and simple.
The given denition seems a very simple, however some peculiarities
of risk analysis should be taken into account. These peculiarities are:
the uniqueness of any risk situation;
the long chain of causes, that is necessary to be taken into account
in risk situation analysis;
absence of needed statistical data.
All these circumstances lead to the necessity to construct for any risk
model its own probability space, which is usually realized in terms of
the risk tree construction, that will be considered later.
1.3. Classication of risk models
The above examples give the possibility to classify risks accordingly
to their generation.
But this approach does not help for the general theory development,
since it distracts from general notions and methods of risk analysis.
Therefore in further we focus on general problems of risk modelling
and analysis. There are three possible approach for random phe-
nomenons study:
theoretical (analytical);
statistical;
subjective (based on subjunctive probabilities and expert analysis).
The rst one is good, but it has limited applications, because it is
based on analysis of the considered phenomenon.
The second one is theoretically universal, nevertheless not always
practically applicable because of necessity collection and elaboration
enough large information
The third approach has an evident defect, that is its subjectivity.
Risk models traditionally are divided into:
individual risks models and
collective risks models.
An individual risk is risk, connected with one-point risk event
though possibly from wide family of events, while
Acollective risk model deal with sequence of risks events, occurred
in time jointly with its damages. These phenomenons are studied in
the framework of risk processes.
We will also divide individual risks into:
simple risks and
compound risks.
A simple risk is characterized by the possibility to evaluate or to
estimate its probabilistic characteristics directly.
A compound risk is characterized with many dierent events and
leads to numbers consequences. In this case it is natural to represent
it as a chain of components (simple risks), each of which could be
described in the framework of simple individual risks.
In mathematical terminology
An individual risk is probabilistic model (, T, P), on which
two-component r.v. (T, X) is dened,
the rst component T represents the time up to risk event A oc-
currence beginning from some xed epoch,
the second one X denotes a damage from this risk event.
A collective risk is probabilistic model (, T, P), on which a
sequence of two-component r.v.s (S
n
, X
n
) : n = 0, 1, . . . is dened,
the rst components S
n
represent the time up to n-th risk event
A
n
occurrence beginning from some xed epoch,
the second ones X
n
denote damages from these risk events.
Therefore construction and study of the probabilistic risk model for
dierent risk situations compose one of aspects of the mathematical
risk theory.
The time T of risk event occurrence should be measured from some
natural initial epoch t
0
of the process beginning.
In reliability theory this epoch is the equipment beginning exploita-
tion epoch.
In the life insurance models appropriate epoch is the birth epoch.
Nevertheless, in many practical situations (for example in some
catastrophic events in nature: earthquakes, tsunami, etc.) it is im-
possible to x some specic beginning epochs.
Note also that if a risk situation is studied in a xed time interval,
then the risk event can not occurs during this interval at all. Therefore,
Three type of risk models should be considered.
Short-time model, where the probability of risk event occurrence
is mach more smaller then one
Middle-time model, where the probability of risk event occurrence
is smaller then one.
Long-time model, where the probability of risk event occurrence
equals to one.
1.4. Additions
Control questions.
Examples.
Exercises.
Bibliographical notes.
2. Risk measurement
In this section the main risk measure and some special its character-
istics will be proposed.
2.1. Risk distribution
Above an individual risk was dened as a two-component r.v., both
of which without of lost generality can be supposed to be positive.
Therefore, it is determined by its cumulative distribution func-
tion (c.d.f.)
F(t, x) = PT t, X x. (1.1)
Remark. The damage itself is a multi-dimensional value, and more-
over, for some applications it can be functional. Therefore, it can be
considered as an element in some complex (may be functional) space.
Nevertheless, further we will limited ourself mainly with positive r.v.
for damage.
In most practical situations the information about joint distribution
of time and damage of risk event is not accessible, and we need to
limited ourselves with only marginal c.d.f. of times
F
T
(t) = PT t (1.2)
and damage size
F
X
(x) = PX x. (1.3)
Later in 5 some parametric families of distributions for times and
damages description will be done.
If risk is considered at xed time interval, then instead of risk event
occurrence time T it is more convenient to consider the probability PA
of the risk event A and a conditional c.d.f. of damage given A,
G(x; A) = PX x[A.
In this case unconditional damage size has a form with a jump at zero,
because there is no damages if risk event does not occurs,
F
X
(x) = 1 P(A) + P(A)G(x; A)).
In general, it is more convenient to measure risk by the distribution
of risk event time occurrence F
T
(t) = F(t) and conditional risk damage
distribution given T
G(x; t) = PX x[T = t. (1.4)
Therefore, their joint distribution is
F(x, t) =
_
t
0
G(x; u)dF
T
(u). (1.5)
In the simplest case it is supposed that time and damage are inde-
pendent.
G(x; u) = G(x) = F
X
(x) and F(x, t) = G(x)F(t).
In many practical cases this assumption is quite admissible with only
the remark that the future damages at given time should be discounted
with some discount rate s and therefore the future damage is measured
with its present value, given with
X = e
sT
X.
Really, to cover the damage of the size X after the time T it is
enough to put in the bank sum

X under s%. Therefore the c.g.f of
damage present value is
F
X
(x) = P

X x =
_

0
PXe
st
x dF
T
(t) =
=
_

0
F
X
(xe
st
) dF
T
(t). (1.6)
Everywhere later in this course it is supposed that r.v. T and X
are independent, and we will denote their c.d.f. as F(.), and G(.)
respectively.
In reliability (and engineering risk) theory the tail of the c.d.f. F
T
(t)
R(t) = 1 F
T
(t) = PT > t (1.7)
is usually called by reliability function (in demography and in-
surance it is called with survival function). Following to these
traditions it will be called here by risk function.
For continuous distributions these functions plot at the gure 2.1.
Fig. 2.1. C.d.f. time to risk event and reliability function.
For continuously observed r.v. it is more convenient to model their
distributions with the help of probability density function (p.d.f.)
f(x) = F
(x).
Therefore, the c.d.f. can be represented in terms of p.d.f. in the form
F(x) =
_
x
0
f(u) du. (1.8)
In the most practical cases the time and the damage are measured
in discrete units. In this case an appropriate model is discrete dis-
tribution
f
k
= PT = k, g
k
= PX = k (1.9)
where k represents the number of time or damage units. Discrete
distributions are also used for modelling compound distributions in 6.
2.2. Risk intensity and hazard rates
Since the times to risks events are measured usually fromsome special
time (or event), it is very important to know conditional distribution
of the residual time to risk event, given time t after natural
beginning of the process. This is the conditional probability that the
risk event occurs in time interval (t, t + x], given that it does not
take place before the time t. (It should not be confused with two-
dimensional distribution (1.1)).
F
T
(x; t) = PT t + x[T > t =
Pt < T < t + x
PT > t
=
=
F(t + x) F(t)
1 F(t)
=
R(t) R(t + x)
R(t)
. (1.10)
For the small values of x one can get:
F(x, t) =
f(t)
1 F(t)
x = (t)x.
More strongly this function is dened by the formula
(t) = lim
0
1
F(t + ) F(t)
1 F(t)
=
f(t)
1 F(t)
, (1.11)
where function (t) represent conditional instantaneous probability
density of risk events occurs at time t after the natural beginning of the
process and it is called risk hazard rate function. The integral of
it
(t) =
_
t
0
f(u)
1 F(u)
du = ln(1 F(t)) (1.12)
is called a hazard function.
Remark. In reliability theory the function (t) is known as hazard
rate, and in demography it is known as mortality rate.
With risk hazard rate function one can evaluate the probability of
risk event occurrence during a small interval t at the time t after its
natural beginning time with the area under the curve as it is shown in
the gure 2.2.
Fig. 2.2. Hazard rate function.
The equality (1.12) allows to represent c.d.f. of time to risk event
and the risk function in terms of risk hazard function
1 F(t) = R(t) = exp
_
t
0
(u) du = exp(t). (1.13)
Analogously, for the probability of risk occurrence in the time interval
(t, t + x] one can nd
F(x; t) = PT t + x[ T > t = exp
_
_
_
t+x
_
t
(u) du
_
_
_
. (1.14)
Remark. Jointly with the h.r.f. in time in dierent models it
might be useful to consider also the hazard rate in space. It might be
called as intensity (rate) of risk expansion. For example it is
possible to suppose that the forrest re expansion has a downward risk
rate expansion. This means that the probability of localization and
stopping of re at the beginning stage is enough high, and it decreases
with its expansion up to some limit, dened by another factors, after
that it could increase again.
2.3. Generating functions and their properties.
The generating functions is a very useful tools for dierent charac-
teristics of risk calculation.
Denition 2.1. Let G is a distribution of a non-negative r.v. X,
then the function
g(s) = Ee
sX
=
_
0
e
sx
G(dx) =
_

0
e
sx
g(x)dx
is called the moment generating function (m.g.f.) of r.v. X,
and/or its c.d.f. G.
Note that up to the sign it coincides with the Laplace transform of
the p.d.f. or Laplace-Stiltjes transform of the c.p.f. of r.v. X.
g
L
(s) = Ee
sX
=
_
0
e
sx
G(dx) =
_

0
e
x
g(x)dx = g(s).
Denition 2.2. Let p
k
, k = 0, 1 . . . is a distribution of an
integer-valued r.v. N, then the function
p(z) = Ez
N
=
k=0
z
k
p
k
is called the probability generating function (p.g.f.) of r.v. N,
and/or its distribution p
k
, k = 0, 1 . . . .
Remark 2.1. The coecients of Taylor expansion of m.g.f. at
point s = 0 give the moments of r.v. X, and the coecients of Taylor
expansion of p.g.f. at point z = 0 produce up to known multipliers the
distribution of r.v. N.
Remark 2.2. In spite of m.g.f. and p.g.f. are dened dierently
for dierent r.v.s, there exist a close connection between them, and
they are connected with one more transformation of r.v. distributions,
namely with characteristic functions. However, we will not touch of
these connections, since in further we will not use it. In the context for
both of these functions we will the term generation functions (g.f.).
The application of these function is based on their properties, that
represented in the following theorems.
Theorem 2.1. A m.g.f. g(s) of any non-negative r.v. X is unique
determined in all region Re s 0 of a complex variable s. A p.g.f.
p(z) of any integer-valued r.v. N is unique determined in all region
[z[ 1 of a complex variable z. The distributions of appropriate r.v.s
are uniquely reconstructed with their g.f.s.
Theorem 2.2. G.f. of the sum of independent r.v.s equals to the
product of g.f. of summands. In other words, g.f. of the convolution
of distributions equals to the product of their g.f.s.
Proofs of these theorems contain in any textbook on probability
theory, and it is omitted here.
Denition 2.3. A function f(z) is called absolutely monotone
at the segment [a, b], if it is innitely many times dierentiable inside
of this segment and f
(n)
(z) 0 for a < s < b; a function f(s) is called
completely monotone at the segment [0, ], if it is innitely many
times dierentiable for s > 0 and (1)
n
f
(n)(s)
0 for s > 0.
Theorem 2.3. G.f.s are analytical inside of the region of its de-
nition and all derivatives of the p.g.f. are positive, while all derivatives
of the m.g.f. are sign-alternating. In other words p.g.f.s are absolutely
and m.g.f.s are complete monotone functions.
Proof can be nd in (Feller, 1966) ??, and it is omitted here.
Applications of the absolutely and completely monotone functions
are based on the following theorems.
Theorem 2.4.
1. If f and g are complete monotone functions, then fg is also complete
monotone function.
2. If f is a complete monotone function, and g is a positive function
with a complete monotone derivative, then the function f(g) is also a
complete monotone one.
Proof should be fullled as an exercise.
One more useful property of g.f.s concerns to the calculation of sums
of random number of r.v.s. It is based on the following theorem which
is a corollary from theorems 2 and 4.
Theorem 2.5. If p(z) is a p.g.f. of a integer-valued r.v N, and
g(s) is a m.g.f. of i.i.d. r.vs X
i
i = 1, 2, . . . independent of N, then
the m.g.f. of compound r.v.
Y =
N
i=1
X
i
equals to
g
Y
(s) = p( g(s)). (1.15)
Proof is obtained by the simple calculation with the help of the
complete probability formula,
g
Y
(s) = Me
sY
=
k=0
p
k
M
_
e
sY
[N = k] =
k=0
p
k
g
k
(s) = p( g(s)).
These properties are widely used for dierent characteristics of com-
pound distributions calculation, especially for calculation of the com-
pound distributions moments.
2.4. Moments and other risk characteristics.
Not only functional characteristics of risk, but also some numerical,
especially mean value and variance for the time up to risk event,
and appropriate mean value and variance of damages are interest-
ing in practice.
T
= ET =
_

0
t f(t) dt =
_

0
(1 F(t) dt =
_

0
R(t) dt (1.16)
2
T
= DT = E(T
T
)
2
=
_

0
(t
T
)
2
f(t) dt. (1.17)
Remind that mean characterizes the center of probabilistic weight
of a r.v., while the variance characterizes of dispersion of appropriate
r.v. around its mean value. In nance mathematics this characteristic
is often used as risk notion.
The applications of these methods for the risk moments calculation
will be considered in 6.
2.5. Additions
Examples.
1. Let p
k
be Poisson distribution with mean > 0,
p
k
=

k
k!
e
, k = 0, 1, 2, ...
Acc. to def. its p.d.f. is
p(z) = e
(1z)
.
2. Let p
k
be Poisson distribution with mean > 0. Calculate the
convolution
g = p
(1)
... p
(n)
Taking into account that p
(j)
equals to
p
j
(z) = e
j
(1z)
and using the second parrt of the Th. 2 for g(z) one can nd
g(z) =
n
j=1
p
j
(z) =
k
j=1
e
j
(1z)
,
or
g(z) = e
(
1
+...+
k
)(1z)
.
Now from the rst part of the Theorem it follows that g is the Poisson
distribution with mean
1
+ ... +
k
.
3. Using generating functions method nd compound damage. If (s)
is a m.g.f. of damages Y
i
, then from part 2) of the theorem it follows
that
(s) =
k=0
p
k
_
e
sx
g
k
(x) dx =
k=0
p
k
[(s)]
k
.
Let
p(z) =
k=0
p
k
z
k
be the p.g.f. of the damages number N. Then
(s) = p((s)).
Exercises.
1. Proof the rst part of the Theorem 2.1.
2. Proof the Theorem 2.2.
3. Some classes of r.v.s and operations with them
In this section some special operations with non-negative r.v.s, and
some classes of distributions such r.v.s will be considered.
3.1. Some operations under r.v. and their distributions
For risk analysis, especially for damage calculating some special op-
erations under r.v.s and their distributions are needed. In this section
we consider some special techniques for this.
3.1.1. Shift.
Some times jointly with r.v. X it is necessary to consider also r.v.
Y = Xa, where a is some constant. This situation arise, for example,
in reinsurance, when the main insurer take for himself risks with the
damage not grater than a, and a reinsurer cover the claims which are
grater than a. Such an operation is called as a shift, and the c.d.f. of
shifted r.v. equals
F
Y
(x) = PX a x = F
X
(x + a).
3.1.2. Scaling.
For the unit of measuring changing and/or for reducing dierent r.v.
to the same unit of measure the operation of scaling is used. This
operation consists in multiplying of a r.v. by some constant a. The
c.d.f. of scaled r.v Y = aX equals
F
Y
(x) = PaX x = F
X
_
x
a
_
.
3.1.3. Truncated distribution.
To truncated distribution one refers to as a conditional distribution
of a r.v. under condition that it takes its values only in some given
subset of its previous values. This operation is used both in dierent
theoretical calculation and in some applications. A distribution F(.)
truncated, for example to the segment [ab], is
F
[ab]
(x) = PX x[a x b =
F
X
(x)
F
X
(b) F
X
(a)
1
{axb}
.
3.1.4. Summation.
If X
1
, ..., X
k
are independent r.v.s with c.d.f.s G
i
(x) and p.d.f.s
g
i
(x), then the c.d.f. G
(k)
(x) of their sum
Y = X
1
+ ... + X
k
is given for all i = 1, k with the recursive formula
G
(0)
(x) = 1
{x0}
, G
(i)
(x) =
x
_
0
G
(i1)
(x u)g
i
(u)du, (1.18)
which is known as a convolution of G
i
(x) and is denoted by
G
(k)
(x) = G
1
G
2
G
k
(x).
In the case of i.i.d. r.v. the last formula takes more simple form
G
(0)
(x) = 1
{x0}
, G
(i)
(x) =
x
_
0
G
(i1)
(x u)g(u)du. (1.19)
For discrete i.i.d. r.v. X
i
with the common distribution
g
j
= PX
i
= j j = 0, 1, . . .
the formula (1.19) is changed to the following one
g
(0)
j
= 1
{j=0}
, g
(k)
j
=
j
i=0
g
((k1))
ji
g
i
. (1.20)
3.1.5. Compound distributions.
The sum Y of random number N of random components X
i
(i =
1, N) is known as compound r.v. and its distributions as com-
pound distribution. Put
Y =
_
0, for N=0,
X
1
+ X
2
+ ... + X
k
, for N=k=1,2,3....
Denote the distributions of r.v. N and X
i
i = 1, N by
p
k
= PN = k, k = 0, 1, 2, ... and G
k
(x) = PX
k
x.
Then taking into account that the c.d.f. of the sum X
1
+ ... + X
k
of
xed number of independent r.v.s is G
(k)
(x) one can get
PY x = p
0
1
{x0}
+
k=1
p
k
G
(k)
(x). (1.21)
Notice that the index k here is not any more a r.v. but an integer, and
the c.d.f. G
(k)
(x) is determined with the convolution of c.d.f. of r.v.
X
1
, ..., X
k
.
For calculation of distributions of sum and compound damages it is
necessary to use the convolution formula, which is not enough conve-
nient for calculation. In these cases a convenient tools are characteristic
or generating functions, considered in section 2.3.
These functions are used for modelling, analysis, and dierent char-
acteristic calculation both time to risk event occurrence and values of
damages.
3.1.6. Mixture.
At last consider the situation, when phenomenon of risk describes
as some family of risk events, from which only one is realized in concrete
situation. This is usual situation in engineering risk models, where sev-
eral dierent risk events can occurs. Suppose that this family contains
nite or denumerable set of disjoint events (any denumerable family
can be reduced to disjoint one),
T = A
k
: k = 1, 2, . . . ,
each of which leads to its own damage X
k
with c.d.f. G
k
(x). Denoting
with 1
{A
k
}
the indicator functions of these events the resulting damage
Y can be represented as
Y =
k=1
X
k
1
A
k
.
The c.d.f. G(x) of such damage is
G(x) = PY x =
k=1
p
k
G
k
(x) (1.22)
and it is called by mixture of c.d.f.s G
k
(.).
3.1.7. Integrated tail distribution.
The distribution
F
s
(x) =
1
F
x
_
0
(1 F(u)) du,
where
F
=
_
0
(1 F(u)) du is the mean of distribution F is known
as a integrated tail distribution for given distribution F.
It is clear, that this distribution exists only for distributions with
nite mean values.
This distribution arise, for example, in reliability theory for station-
ary distributions of the age and the residual life time of elements
in repairable systems, which is modelled as renewal processes.
3.2. Heavy-tailed distributions
In this section we will partially follow to the book ??.
In risk theory an important role play the distributions, that model
large damages, so called heavy-tailed distributions (HT-distributions).
The idea of large damage can be treated by dierent ways, for ex-
ample under the large damage one can understand the damages, for
which:
(i) the ratio of the maximal member in some sample to the any one
quickly increase with the sample size increasing; or
(ii) distribution of the maximal member of a sample is closed to
distribution of its sum; or
(iii) the maximal member of a sample is larger than the sum of its
given part.
It is not known the direct formalization some of these properties to
deduce the formal denition of HT-distribution.
Below it will be shown that some formal denition of HT-distributions
leads to fullling for it some of above remind properties.
Denition 3.1. The distribution G is called HT-distribution, if its
m.g.f. g(s) does not prolonged into right half plane, or formally
g(s) =
_

0
e
sx
dG(x) = for all s > 0.
For the motivation of this denition is the following reason: if the
m.g.f. is extended into right-hand half-plane, then the appropriate
r.v. possesses all moments, and the tail of it distribution exponentially
increases,
G(x) = 1 G(x) e
cx
for some c > 0.
Vice versa the non-possibility of the extension of m.g.f. into the right-
hand half-plane means that the distribution has only a nite number
of moments, and the point s = 0 is a particular point for a analytical
function g(s).
The following theorem describe a characterizing property of HT-
distributions. Denote by
G
= lim sup
x
(x)
x
= lim sup
x
log(1 G(x))
x
,
where (x) is a hazard function of the distribution G(x).
Theorem 3.1. If
G
= 0, then G is an HT-distribution.
Proof. Let
G
= 0. Then for any > 0 there exist x
0
such that
(x) x for all x x
0
and, therefore, due to the hazard function
denition, there exists a value c > 0 such that
1 G(x) ce
x
(1.23)
for all x x
0
. It follows from here that
_
0
e
sx
(1 G(x))dx =
for all s . Since is arbitrary the last expression holds for all s > 0,
which due to the denition means that G is an HT-distribution.
Note that the expression (1.23) involve, that
lim
x
e
sx
(1 G(x))dx =
for any s > 0. The last expression means that all HT-distributions
possess the property of sub-exponentiality, i.e. their tails increase
slowly any exponent. Nevertheless, under sub-exponential family usu-
ally understood some more narrow class of distributions, considered in
the next subsection.
3.3. Sub-exponential distributions
Denition 3.2. A distribution G is called sub-exponential one,
or S-distribution, if for any n
lim
x
1 G
n
(x)
1 G(x)
= n. (1.24)
Consider some of the properties of S-distributions. Firstly, the direct
corollary of the denition is the fact that the S-distributions are dened
for all real numbers, i.e.
G(x) < 1 for all x R
+
.
Secondary, the tails of maximum and the sum of i.i.d. S-distributed
r.v.s are asymptotically the same.
Theorem 3.2. Let X
i
(i = 1, n) be i.i.d. r.v.s with S-distribution
G. Then
P
_

1in
X
i
> x
_
P
_
max
1in
X
i
> x
_
x . (1.25)
Proof. Passing to the limit when x in the ratio
P
_
1in
X
i
> x
_
Pmax
1in
X
i
> x
=
1 G
n
(x)
1 G
n
(x)
taking into account the denition of sub-exponentiality, one can nd
lim
x
1 G
n
(x)
1 G
n
(x)
= lim
x
1 G
n
(x)
(1 G(x))(1 + G(x) + + G
(n1)
(x))
= 1.
Therefore, this theorem shows that S-distributions possess an im-
portant property (ii) of large damages. If the inverse property were
true, it will give the possibility to state that the property (1.24) is a
characterization property of S-distributions. But it is unknown yet.
The following criterion shows that to check that some distribution
G is S-distribution it is enough to check the property (1.24) only for
n = 2.
Theorem 3.3. Sub-exponentiality criterion. The distribu-
tion G is an S-distribution if and only if
lim
x
1 G
2
(x)
1 G(x)
= 2. (1.26)
Proof. The necessity is obvious. The induction over n is used to
prove the suciency. Really, let the relation (1.24) true for n = 2 and
suppose that it is also true for k = n 1. Then accordingly to
1 G
n
(x) = 1 G
(n1)
G(x) = (1 G
(n1)
) G(x) + 1 G(x)
it is sucient to show, that
(1 G
(n1)
) G(x) 1 G
(n1)
(x).
Denoting 1 G
(n1)
(x) = B(x), for some v, such that 0 v x the
following inequality true
[B G(x) B(x)[ = [
_
x
0
B(x u)dG(u) B(x)[
[
_
v
0
B(x u)dG(u) B(x)[ +
+ [
_
x
v
B(x u)dG(u)[.
Using the monotonicity of the functions B and G choose the value v
by such a way, that 1 G(v)

2
, and then choose an x by such a
way, that B(x v)

2
. Taking now into account that
B(x)(1 G(v))
_
v
0
B(x u)dG(u) B(x) B(x v) B(x)
one get
[B G(x) B(x)[ .
Show now that any S-distribution has a heavy tail.
Theorem 3.4. Any S-distribution is also HT-distribution.
Proof. Let G is an S-distribution, that means
lim
x
1 G
2
(x)
1 G(x)
= 2.
Acc. to the Th.1 to prove that G is an HT-distribution, one should
show, that
G
= 0. For this let us show rstly that expression (1.26)
involves
lim
x
1 G(x x
)
1 G(x)
= 1 for any x
> 0.
Really, transformation of the relation (1.26) shows that
(G(x) G(x
))
1
_
1 G
2
(x)
1 G(x)
1 G(x
)
_
1 G(x x
)
1 G(x)
1,
from here by passing to limit one get the result.
At least by passing in previous relation to logarithm one can nd
lim
x
(ln

G(x x
) ln

G(x)) = lim
x
((x) (x x
)) = 0
for any x
> 0. Therefore for each > 0 there exists x

0
> 0 such that
for all x > x
0
the inequality (x) (x1)) < holds. The iteration
gives
(x) (x 1)) + (x 2) + 2 (x n)) + n,
where n is such that x
0
x n < x
0
+ 1. Therefore,
(x) sup
x
0
1x
x
0
(x
) + (x x
0
) for x x
0
.
From here due to arbitrarily of it follows
lim
x
G
(x)
x
=
G
= 0.
3.4. Additions Control questions.
Chapter 2.
INDIVIDUAL RISK MODELS
(ENGINEERING RISK THEORY)
In this chapter we consider the main aspects of the individual risk
models. These models are mostly used in engineering risk theory, what
explain the subtitle of the chapter.
Theoretically the problem of engineering risks investigation seems a
very simple: for this it is necessary to determine only the risk distri-
bution F(t, x). Nevertheless, in practice it is not a simple problem,
because of
complexity of real risk situations,
non-possibility to propose some clear theoretical bases for risk dis-
tribution modelling, and
absence of enough statistical data for its estimation.
Therefore, in fact the problem is reduced to the probabilistic space for
any concrete risk situation construction. An approach, which reduces
the complex problem to the hierarchical sequence of more and more
simple ones, was proposed for this. It is realized by means the risk tree
construction and analysis.
CHAPTER 2. INDIVIDUAL RISK MODELS (ENGINEERING RISK THEORY) 68
4. Methodology for risk analysis
4.1. Introducing remarks
Turning to risk situations modelling, note their manifoldness from
one side and the seeming theoretical simplicity from the other one.
Any concrete model for the risk situation evolution depends on the
problem considered and should be studied in each case separately. Here
we propose only a methodology for individual risk modelling and
investigation following to Henley & Kumamoto, 1992 [?].
The main peculiarity of risk events and phenomena is their com-
plexity and heterogeneity of its physical nature.
Usually risk events are consequences of many another gradually de-
veloped or instantaneous in time events.
Especially, engineering risks usually result of
technical systems or its aggregates failures,
failures in control systems or
operators errors.
For their turn each of these reasons can be consequence of many
others. Therefore, for analysis of any risk situation it is naturally to
represent it as an aggregate of more simpler and/or smaller events, in
order to evaluate the characteristics of whole risk in terms of those.
Note that from probabilistic point of view this methodic is a pro-
cedure for the probabilistic space construction as a graph of tree type,
and its marking provides calculation of the time to main risk event
occurrence and a whole damage as its result on the base of generated
events.
Times to all initial and intermediate events and appropriate damages
should be estimated by usual theoretical, statistical or expert methods.
The analysis of the risk tree allows to nd some bottlenecks in con-
sidering risk situation and propose some actions for the risk increasing,
and therefore to decide the problem of risk management.
4.2. Preliminary risk analysis
From practical point of view this procedure can be realized in terms of
risk tree construction. In reliability theory analogous construction is
called a fault tree. In the situation, when the family of interconnected
risks study is needed, the risk forest can be also useful. The fault tree
analysis was rstly developed in Bell Telephone Lab. in early 60-th.
Acc. to [?] There are two approaches for analyzing causal relations:
one is forward analysis, the other is backward analysis. A
forward analysis starts with a set of failure events and proceeds forward,
seeking possible consequences resulting from the events. A backward
analysis begins with a system hazard and traces backward, searching
for possible causes of the hazard
For preliminary risk analysis the forward analysis is preferable. The
preliminary risk analysis can be divided into several stages and steps.
Stage I.
Identifying of the hazard(s) and/or risk(s). At this stage under
risk is understood its substantial component, that further should be
represented as a mathematical model, i.e. as a two-dimensional r.v.
This stage consists from several steps:
Step 1. Consists in description of risks and their origin and include:
Description of types of risks,
Description of risks sources and distribution of risks accordingly
to their sources,
Description of the restrictions for risks (in order to excluding
small risks out of consideration).
Step 2.
Classication of risks into four categories:
I class neglected accordingly their consequences risks,
II class boundary risks,
III class critical risks,
IV class catastrophical risks.
Step 3.
This step includes description of the preventive measures for elimi-
nating risks of IV class, and, possible, decreasing risks of the classes
II and III. These measures are represented as a decision tree.
Stage II.
This stage consists in discovering of the risk sequences (construction of
the risk development process). The methods for this is the risk tree
(fault tree, event tree) construction, it will be detailed in next section.
Stage III.
Analysis of possible consequences. At this stage it is necessary to eval-
uate possible consequences of each risk event in sense of it time damage
and probability. This stage allow to realize the risk tree marking, and
will be detailed later.
Formally this methodic can be realized with help of risk tree con-
struction and analysis, and it consists in three steps:
risk tree construction,
risk tree marking
risk tree analysis.
4.3. Risk thee construction
A major goal of risk analysis is to reduce the probability of risk
event (or failure for engineering risk) and to exclude (or decrease) its
consequences (damages): human, economic environmental etc. losses.
As it was mentioned above the methodic of a risk analysis includes
three steps. At the rst step the risk tree construction is realized.
The risk tree ia a graph of the tree type, which vertex are the events,
and the arcs show the events, caused the given one. A general structure
of a risk (as an example, fault) tree is shown at the gure 4.3.1.
Figure 2.1. A scheme of a risk tree construction.
For convenience of the results representation some special symbolic
for dierent types of events and its connections was proposed. It is
shown in the tables bellow.
Figure 2.2. The symbols for dierent type of risk events connections.
Figure 2.3. The symbols for the events presentation.
A simple examples of these symbols use are presented in the g-
ures 4.3.4 4.3.5.
Figure 2.4. An example of the symbol AND using.
Figure 2.5. Example of the others symbols using.
A simple example of an auto engine fails is shown at the gure 4.3.6.
Fig. 4.3.4. A simple example of a risk tree.
4.4. Risk thee marking
The second stage consists in marking of the graph with
(i) probabilities of risk events arising,
(ii) times durations of their evolution and
(iii) connected with these events damages.
Denote by
p
(1)
i
1
the conditional probabilities risk events (failures) arising caused
by i
1
reason at the rst level,
p
(2)
i
1
i
2
the analogous characteristics at the second level, etc.
p
(k1)
i
1
i
2
...i
k1
the conditional probabilities of the risk events arising caused
by i
k1
reason at the (k 1)-th level, and
p
(k)
i
1
i
2
...i
k
the conditional probability of elementary risk events (at the
last k-th level).
Further denote by
T
(l)
i
1
i
1
...i
l
the time of appropriate event development, and
X
(l)
i
1
i
1
...i
l
the size (additional) of damage from the event.
These r.v.s should be described with their c.d.f.
F
(l)
i
1
i
1
...i
l
(t) = PT
(l)
i
1
i
1
...i
l
t
G
(l)
i
1
i
1
...i
l
(x) = PX
(l)
i
1
i
1
...i
l
x
or their m.g.f. (or LTs)
f
(l)
i
1
i
1
...i
l
(s) = MexpsT
(l)
i
1
i
1
...i
l
,
g
(l)
i
1
i
1
...i
l
(v) = MexpvX
(l)
i
1
i
1
...i
l
.
These characteristics represents of the risk tree marking.
It is not very simple to identify these characteristics. They could
be nd as a result of some theoretical study (on the base of some
physical models), or results of statistical analysis, or as expert analysis
evaluation.
Moreover, it is necessary to note that in order to coordinate this me-
thodic with the rules of probability calculation it is necessary strongly
follows to the following rules for the risk tree construction.
1. Each branching should be done into disjoint events, a common part
of joint events should be represented as a separate event.
2. On the branches of the risk tree (except of the last level) only con-
ditional, given the above level events, probabilities and distributions
must be included.
It should also note that the proposed methodic admits the risk tree
construction for all short-, middle- and long-time risk models. In two
rst cases the additional non-risk events should be included in risk tree
in each level, where it is necessary.
4.5. Risk tree analysis
Analysis of the risk tree is based of the given marking and consists in
calculation of the nal risks. Under the given marking the probability
of complex event composed of the sequence of events i = (i
1
i
2
. . . i
k
)
equals
p
i
= p
(1)
i
1
p
(2)
i
1
i
2
. . . p
(k)
i
1
i
2
...i
k
. (2.1)
In this case the full time of the risk event development and a entire
damage of it are
T
i
= T
(1)
i
1
+ T
(2)
i
1
i
2
+ + T
(k)
i
1
i
2
...i
k
, (2.2)
X
i
= X
(1)
i
1
+ X
(2)
i
1
i
2
+ + X
(k)
i
1
i
2
...i
k
. (2.3)
Therefore, the m.g.f. of the full time up to risk event i and entire
damage (under assumption about its independency along the branches)
are
f
i
(s) =

f
(1)
i
1
(s)

f
(2)
i
1
i
2
(s) . . .

f
(k)
i
1
i
2
...i
k
(s) (2.4)
and
g
i
(v) = g
(1)
i
1
(v) g
(2)
i
1
i
2
(v) . . . g
(k)
i
1
i
2
...i
k
(v). (2.5)
From these relations it is not dicult to calculate the m.g.f.s of the
time of the risk event development and the brought them damage
f(s) =
i
p
i

f
i
(s) =
=
i
i
,i
2
...i
k
p
(1)
i
1
p
(2)
i
1
i
2
. . . p
(k)
i
1
i
2
...i
k
f
(1)
i
1
(s)f
(2)
i
1
i
2
(s) . . . f
i
1
i
2
...i
k
(s),(2.6)
g(v) =
i
p
i
g
i
(v) =
=
i
i
,i
2
...i
k
p
(1)
i
1
p
(2)
i
1
i
2
. . . p
(k)
i
1
i
2
...i
k
g
(1)
i
1
(v)g
(2)
i
1
i
2
(v) . . . g
i
1
i
2
...i
k
(v).(2.7)
Especially, for the mean values one can get
T = MT =
i
p
i
T
i
(2.8)
X = MX =
i
p
i
X
i
(2.9)
This approach allows to decompose a complex risk event into the se-
quence of more simple. This gives the possibility precisely estimate its
characteristics using or statistical data for analogous events in appro-
priate situations, or experts appreciation for these more simple events.
The analysis of the risk tree allows to nd some bottlenecks in con-
sidering risk situation and propose some actions for the risk increasing,
and therefore to decide the problem of risk management.
The very useful byproduct of the risk tree analysis is the possibility
of risk analysis in terms of its stability and non-sensitivity to the shapes
of initial risk characteristics distributions.
In spite of the proposed methodic is developed for engineering risk
analysis it also can be successfully applied to analysis of business risks,
because of, for example, for any business-plan design it is also necessary
to take into account all possible risk events, and it can be done in the
framework of a risk tree construction.
4.6. Concluding remarks
[1.] There exist many dierent computer tools for special cases of
risk analysis. The bibliography could be nd in Henly&Kumamoto,
1992 [?], and Solojentsev, 2000 [23].
[2.] Nevertheless, there is not yet a computer tool, which could help
user to construct and analyzed his own risk tree. Note that all steps of
the procedure above can be fullled with the help of computer. It can
be used in each stage of the procedure:
for risk tree building in dialog regime,
for risk tree marking in dialog regime with experts,
for risk tree analysis with direct calculation or with simulation.
This procedure can be formalized and realized with a computer. This
computer tools could be constructed as some friendly interface system
that allows to construct and change the risk tree to dierent kind of
specialists.
[3.] Note that from probabilistic point of view the proposed me-
thodic is a procedure for the probabilistic space construction as a graph
of tree type, and its marking provides the time to main risk event and a
whole damage as its result calculation on the base of generated events.
Estimation of times to all initial and intermediate events and appro-
priate damages should be estimated by usual theoretical, statistical or
expert methods.
[4.] One of the main problems of the proposed methodology is the
risk tree marking. Three main approaches can be used for this
theoretical
statistical
expert
We will not touch in this course some special statistical methods for
input risk characteristic analysis, as well as some special methods for
their expert analysis. We consider here only theoretical approach and
in the following section some parametric families of distributions jointly
with their characterization properties will be proposed.
In the book of E.D. Solojentsev, 2006 [?] some closed approach, based
on scenario of risk construction and analysis was also proposed.
4.7. Additions
Control questions.
Examples.
Exercises.
1.
Bibliographical notes.
[S] E.D. Solojentsev. Scenario, logic and probabilistic management of
risk in business and engineering. Publishing house Business-Pressa.
Saint-Petersburg, 2006. 537pp.
5. Some parametric families of risk distributions
One of the main problems of the risk theory is the modelling of
times to risk event arising and
damages from the event,
which is based on the characterization properties of distributions.
The nature of arising and development of risk situations is usu-
ally enough complex. Thus, it is expedient that jointly with simple
unite risks it is also need to consider models of compound risks for
enough complex situations.
Because the same parametric families of distributions can be used for
modelling of both time to risk event arising and the damage from it
we consider some parametric families and classes of non-negative r.v.
distributions, that can be used for both of them. Some special charac-
terization properties of these distributions also will be considered.
We begin from some discrete distributions.
5.1. Some discrete parametric families of distributions
The most of observations are xed in discrete of time or damage units,
therefore continuous distributions are only useful models to describe
real situations. Thus, in applications for describing both the time up
to risk event and the value of damage the dierent types of discrete
distributions are used. Moreover, discrete distributions are used in
models of compound damages for number of risks description.
In table 2 at the end of this section some discrete distributions jointly
with their main characteristics, which are often used in risk practice,
are given.
Consider some of them jointly with their g.f., means and variances.
5.1.1. Degenerated distribution
The degenerated distribution is used for description of a non ran-
dom r.v., i.e. of the r.v., which takes only one value b 0 with
probability 1. Its c.d.f.
G(x) = 1
{xb}
(2.10)
has a stepwise graph with a jump of unit size at point b (see g 5.1.1a).
6
-
0
x
G(x)
b
1
Fig.5.1.1a. Degenerated distribution
The m.g.f. mean value and variance for this distribution are
g(z) = Ez
X
= z
b
, EX = b, DX = 0.
Mixture of such types distributions allows to construct two-point
distribution and any discrete distribution as well, that often used for
risk characteristics modelling. The degenerated distribution and its
mixture can be used for claims modelling in dierent insurance models.
Example 5.1.1. Consider some contract of a short-time life insur-
ance, that provides two risk cases: a natural death event A
1
, and
the death resulted by some accident event A
2
. Suppose that the
probabilities of these events are: P(A
i
) = p
i
, i = 1, 2, and the claims
(insurance payments) provided by insurance company are b
i
in case A
i
.
Then the claim p.d.f. will be the two point step-wise function, shown
at the gure 5.1.1b.
6
-
0
x
G(x)
b
1
1
p
1
b
2
Fig.5.1.1b. Mixture of degenerated distribution
5.1.2. Uniform distribution
The uniform distribution is characterized with xed number, say,
n of values of r.v., each of which has the same probability,
PX = i =
1
n
1, n. (2.11)
The graph of c.d.f. has a step-wise form that is presented below at the
gure 5.1.2.
0
1/6
1/3
1/2
2/3
5/6
1
-1 0 1 2 3 4 5 6 7 8
x
F(x )
Figure 2.6. Fig.5.1.2. The graph of uniform distribution.
The m.g.f., the mean value and the variance of this distribution are
Ez
X
=
z
n
1 z
n
1 z
, EX =
1
2
(n + 1), DX
4(n
3
1) 3(n + 1)
2
12
.
The uniform distribution can be used for damage distribution mod-
elling in the cases, when there is not enough information.
Example 5.1.2. Suppose that the repair of a car after an accident
costed b
i
= $100i, (i = 1, 100), and all these payments are equally-
probable. This damage is described with the uniform distribution.
5.1.3. Bernoulli distribution
This distribution is used for description of two-valued r.v. By choose
the scale and shift it is possible to reduce these values to zero and one,
p
k
= p
k
(1 p)
1k
, k = 0, 1. (2.12)
The graph of this distribution is presented at the gure 5.1.3.
6
-
0
x
G(x)
1 p
1
1
Fig.5.1.3. Bernoulli distribution
Its g.f. equals
p(z) = 1 p(1 z),
and mean and variance are
= EX = p,
2
= DX = p(1 p).
The sequence of i.i.d. Bernoulli distributed r.v.s constitute so called
Bernoulli scheme.
Example 5.1.3. Numerous observations during long time over all
world show that for among any 1000 birth approximately 515 are boys
and 485 are girls. Therefore, if one introduce a r.v., that takes value
1 for boy birth, and value 0 for girl birth, it will have a Bernoulli
distribution with p = 0.515
5.1.4. Geometric distribution
This distribution is dened with the formula
p
k
= (1 p)p
k
, k = 0, 1, 2, . . . (2.13)
The graph of this distribution at the gure 5.1.4 is shown.
0
0.1
0.2
0.3
5 10 15 20 25 30
k
g
k
(2/3)
Figure 2.7. Geometric distribution (p =
2
3
).
Its p.g.f. is
p(z) =
1 p
1 pz
and two rst moments are
= EX =
p
1 p
,
2
= DX =
p
(1 p)
2
.
This distribution describes the moment of the rst success in
Bernoulli scheme. Among discrete distributions this is the unique
which possesses of the luck of memory property.
Lemma 5.1.1. The luck of memory property
PT k + l[T > l = PT k = p
k
(2.14)
is a characterization property of geometric distribution among discrete
distributions.
Prove this lemma as an exercise.
Example 5.1.4. If some couple plan to have just one boy in their
family, the number of children will be distributed geometrically with
parameter p = 0.515.
5.1.5. Binomial distribution
The binomial distribution
p
k
=
_
n
k
_
p
k
(1 p)
nk
, k = 0, 1, . . . , n, (2.15)
is presented at the gure 5.1.5
0
0.04
0.08
0.12
0.16
0 5 10 15 20 25 30
k
b
k
(2/3)
Figure 2.8. The shape for binomial distribution (n = 30, p =
2
3
).
Its m.g.f. is
p(z) = (1 p(1 z))
n
,
= EX = np,
2
= DX = np(1 p).
is the distribution of number of successes in Bernoulli scheme with
n trials.
Example 5.1.5. Some previous geological investigations show the
presence of oil in given region with probability p. If it is planed to
bore n oil holes, he number of non-empty oil holes among them will be
described by binomial distribution with parameters n, p.
5.1.6. Negative binomial distribution
The negative binomial distribution
p
k
=
_
+ k 1
k
_
p
k
(1 p)
, k = 0, 1, . . . (2.16)
represents the distribution of the trails number in Bernoulli scheme up
to k-th success. The graph of this distribution at the gure 5.1.6.
0.02
0.04
0.06
0.08
0.1
0.12
5 10 15 20
Figure 2.9. The Negative binomial distribution graph.
Its m.g.f. is
p(z) =
_
1 p
1 pz
_

= MX =
p
1 p
,
2
= DX =
p
(1 p)
2
,
Example 5.1.6. If an Oil-drilling company want to investigate
some region up to k-th non-empty hole, the whole number of holes
needed satises to the negative binomial distribution with parameters
k, p, where p is the oil presence probability in the considered region.
5.1.7. Poisson distribution
This distribution is dened with the formula
p
k
=

k
k!
e
, k = 0, 1, 2, . . . , (2.17)
The following gure represents Poisson distribution.
0
0.02
0.04
0.06
0.08
0.1
0.12
0 5 10 15 20 25 30
k

k
(15)
Figure 2.10. The Poisson distribution graph ( = 15).
Its m.g.f. is
p(z) = E
(1z)
,
= MX = ,
2
= DX = .
The main property are stability against summing, which is represented
by the following lemma.
Lemma 5.1.2. The sum of two (and several) Poisson-distributed
r.v.s have the Poisson distribution parameter of which equals to the
sum of parameters of summands.
Prove this lemma as an exercise.
Due to stability property, concerning in previous lemma, the Poisson
distribution is used in many practical cases.
Example 5.1.7. Due to the stability property, contained in Lemma 2,
the Poisson distribution is very good apt for describing dierent kinds of
event ows: number of particles in radio-nuclear disintegration, num-
ber of calls to telephone station, number of E-mails, arisen to some
server, etc.
In table 5.1 the summary of the discrete distributions jointly with
its main characteristics is given.
Table 5.1. Some discrete distributions and their characteristics
Title of dis-
tribution
Distribution Mean value Variance
Poisson
k
k!
e
, k = 0, 1, . . .
> 0

Geomrtric
(1 p)p
k
, k = 0, 1, . . .
0 p 1
p
1 p
pq
(p + q)
2
(1 + p + q)
Binomial
_
n
k
_
p
k
(1p)
nk
, k = 0, 1, . . . n,
0 < p < 1
np
np(1 p)
Negative bi-
nomial
_
+ k 1
k
_
p
k
(1p)
, k = 0, 1, . . .
0 < p < 1, > 0
p
1 p
p
(1 p)
2
Logarithmic
p
k
k ln(1 p)
, k = 0, 1, . . .
0 < p < 1
p
(1 p) ln(1 p)
p(p + ln(1 p))

(1 p)
2
ln
2
(1 p)
5.2. Some parametric families of continuous distribu-
tions
Consider some standard parametric families of continuous non-negative
distributions, which is often used for the time to risk events and simple
damages modelling. In the table 2 at the end of this section some stan-
dard families of such distributions are shown. Bellow some comments
for them are given.
5.2.1. Uniform distribution
The uniform distribution is determined with its p.d.f.
g(x) =
1
b a
1
{axb}
, 0 < a < b, (2.18)
which has a rectangular form (see g. 5.2.1), that gives it another name,
rectangular distribution. The constants a and b are parameters
of distribution. Its c.p.d. is
F(t) =
_
_
0, for t < a,
ta
ba
, for a t b,
1, for t > b,
The graph of this distribution is shown below.
0
0.2
0.4
0.6
0.8
1
-10 0 10 20 30 40
x
F(x )
p (x )
Figure 2.11. C.d.f. and p.d.f. for uniform distribution.
The hazard rate function is
(t) =
_
_
0, for t < a,
1
bt
, for a t b,
does not dened, for t > b,
Mean value and variance for this distribution respectively are
MX =
a + b
2
, DX =
(b a)
2
12
.
Characterization property of this distribution is equali-probable
of any values of r.v. at any equal subintervals inside of segment [a, b].
This distribution can be used both for description of the times of risk
events occurrence and the damage value in situations, when only the
possible boundary values for time or/and value of damage interval are
known, and more detailed information about their distribution absents.
As examples it can be used as property insurance model, when only
the boundaries for estimated property are known, but real value of
claim unknown. Another example could be the failure time of new
equipment, when there is no enough statistical data for it estimation.
Example 5.2.1. Under absence of more detailed information and
statistical data it is possible to suppose that the pipeline lifetime uni-
formly distributed on the interval [0,30] (years).
5.2.2. Exponential distribution
This distribution has a c.d.f.
F(t) = 1 e
t
, (2.19)
where is a parameter. Reliability (survival) function is
R(t) = e
t
, (2.20)
The graph of exponential distribution is presented at the gure 5.2.2.
0
0.2
0.4
0.6
0.8
1
0 2 4 6 8
x
F(x )
p (x )
Figure 2.12. Exponential distribution.
The mean value and the variance equal
T
= MT =
1
,
2
T
= DT =
2
.
The hazard rate function is constant and equals to the parameter of
distribution ,
(t) =
f(t)
R(t)
= . (2.21)
This property of the h.r.f. allows to consider this distribution as a
model of instantaneous failures. Moreover this property is a char-
acteristic property of the distribution
Lemma 5.2.1. Among continuous distributions the exponential
distribution is only one with constant h.r.f.
Proof. Really, from the relation (2.20) one has:
(t) =
f(t)
R(t)
=
e
t
e
t
= .
Another characterization property of exponential distribution
is its luck of memory property, which contains in the following lemma.
Lemma 5.2.2. An exponential distribution is only one for which
the following luck of memory property holds
PT t + x[T > t = PT x = 1 e
x
(2.22)
Proof. Really, using the formula for conditional probabilities one
get
PT t + x[T > x =
PT t + x, T > t
PT > t
=
Pt < T t + x
PT > t
=
=
e
t
e
(t+x)
e
t
= 1 e
x
= PT x.
The inverse statement is obtained from
R(t + x) = PT > t + x = PT > t + x[T > xPT > x =
= PT > tPT > x = R(t)R(x).
Exponential distribution can be used as for description of the time
to risk events arise, as a model for damage. Due to its characterization
properties in reliability theory it is used for description of completely
random failures.
Example 5.2.2. Two girls talk by phone. After one subject they
began to discuss another one and so on. In this case at any point of
time the longevity of residual talk does not depend on the time spent
to it up to now. Therefore, the whole longevity of talk can be described
by exponential distribution.
5.2.3. Shifted exponential distribution
The p.d.f. of this distribution is (see g. 5.2.3)
g(x) = e
(xb)
1
{xb}
, b 0. (2.23)
0
0.02
0.04
0.06
0.08
0.1
10 10 20 30 40 50 60
x
Figure 2.13. The shifted exponential distribution.
Its mean value and variance are
MX = b +
1
, DX =
1
2
.
This distribution can be used both for the time till risk events and
for the damages modelling, when appropriate values do not take values
less than some given constant. For example in insurance it is used for
claims modelling in the case when the claims less than given value do
not compensated (franchise).
Example 5.2.3. Automobile trac at some not very loaded road
can be described with Poisson ow, that means that the intervals be-
tween cars are exponentially distributed. Nevertheless, the movement
rules demand to have some special intervals between cars. Therefore,
the real distribution of the intervals between cars are shifted exponen-
tial one.
5.2.4. Gamma-distribution
The p.d.f. of this distribution is (see g. 5.2.4.)
g(x) =

x
1
()
e
x
1
{x0}
, > 0, (2.24)
where () =
_
0
x
1
e
x
dx is the Gamma-function, and is a scale,
while is a shape parameters. For = 1 it coincide with p.d.f. of
exponential distribution.
0
0.02
0.04
0.06
0.08
0.1
10 20 30 40 50 60
x
Figure 2.14. P.d.f. of Gamma-distribution.
Survival (risk) function equals to
R(t) =

F(t) =
_
t
x
1
()
e
x
dx
Appropriate c.d.f. is presented at the gure 2.15
0
0.2
0.4
0.6
0.8
1
10 20 30 40 50 60
x
Figure 2.15. Gamma distribution.
The closed formula for the hazard rate function does not exists, but
mean value and variance are
T
= MT =

,
2
T
= DT =

2
.
The Gamma distribution has the following stability property.
Lemma. If T
i
: i = 1, 2 have the Gamma distributions with
parameters
i
, , then
i
X
i
has the Gamma distributions with pa-
rameters
i
, .
When Gamma distribution is approximated with normal
one.
Example 5.2.4. The Gamma distribution is used for modelling
non-symmetric unimodal distributions.
5.2.5. Lognormal distribution
The survival function for this distribution is
R(t) = 1
_
ln t
_
=
_
ln t
_
and appropriate c.d.f. is presented at the gure 2.16
0
0.2
0.4
0.6
0.8
1
1 2 3 4 5 6
x
Figure 2.16. Lognormal distribution.
with p.d.f.
g(x) =
1
x
2
e
(log x)
2
2
2
1
{x0}
, (2.25)
0
0.1
0.2
0.3
0.4
0.5
0.6
1 2 3 4 5 6
x
Figure 2.17. p.d.f. of lognormal distribution.
and mean and variance
X
= MX = e
+
2
2
,
2
X
= DX =
_
e
2
1
_
e
2+
2
.
Example 5.2.5. In reliability theory this distribution for repair
time modelling.
From the other side, this is one of so called heavy-tailed distributions,
and it is used for modelling large (catastrophic) damages of risk
events.
5.2.6. Pareto distribution
This distribution has a p.d.f
g(x) =

c
_
c
x
_
+1
1
{xc}
c > 0 (2.26)
0
0.2
0.4
0.6
0.8
2 4 6 8 10
x
Figure 2.18. p.d.f. of Pareto distribution.
with expectation and variance
X
= MX =
c
1
for > 1,
2
X
= DX =
c
2
( 1)( 2)
for > 2.
Example 5.2.6. Pareto distribution is also belongs to the class of
heavy-tailed distributions, and it is used for large harms of risk event
modelling.
5.2.7. Gnedenko-Weibull distribution
The survival function for this distribution is (see g. 2.5.7a).
R(t) = e
t
, (2.27)
the exponential distribution being a special case of this distribution
when = 1. If T is a GW distributed r.v., then the r.v. X = T
has an exponential distribution. Appropriate c.d.f is presented at the

gure 2.19
0
0.2
0.4
0.6
0.8
1
1 2 3 4 5
x
Figure 2.19. The c.d.f. for Gnedenko-Weibull distribution.
Its h.r.f. is
(t) = t
1
and it is presented at the gure 2.5.7.b.
Fig. 2.5.7b. H.r.f. for Gnedenko-Weibull distribution.
The mean value and the variance for this distribution are
T
= MT =
_
1 +
1
2
T
= DT =
_
1 +
2
2
_
1 +
1

The popularity of this distribution in Reliability Theory is explained
by the property of this distribution to be as a limiting distribution for
maximum and minimum if series of i.i.d. r.v.s. Really, because the
failure time of a series system is the minimum of failure times of
its components, and the failure time of a system in parallel is the
maximum of failure times of its components, the following theorem
is very important.
Denote by
X
(n)
= maxX
i
: i = 1, n,
and by
X
(1)
= minX
i
: i = 1, n.
Because X
(n)
increases when n increases, it is natural to nd some
sequences of constants a
n
, b
n
such that the limiting distribution of
r.v.s
Y
n
= a
n
X
(n)
+ b
n
when n
to be proper distribution.
There are two types of limiting distributions for Y
n
dependently on
the behavior of tails distribution of r.v.s X
i
,
1 F(x) = PX > x.
Let
1 G(x) = lim
n
PY
n
> x.
Then the following theorem holds.
Theorem 5.2.1. The following holds:
If 1 F(x) e
x
, when x , then 1 G(x) = e
e
x
.
If 1 F(x) x
, when x , then 1 G(x) = e

x
.
Proof of this theorem is outside of the framework of this course,
and it is omitted.
The second case of this theorem leads to the GW distribution, while
the rst one corresponds to the Gompertz distribution, which in sur-
vival analysis is used.
Example 5.2.7. The life time of a system in series with indepen-
dent identical elements, life time of each of which has a GW distribu-
tion, also has a GW distribution
R
S
(t) = R
1
(t) R
n
(t) = exp (t
+ . . . t
) = e
nt
.
5.2.8. Truncated normal distribution
The truncated normal distribution can be used for descrip-
tion of the epochs for partially forecasting risks, especially in
reliability theory for time to gradual failures.
To explain this settings note that
if an item failure results of some physical parameter a goes out of
limiting value a
1
, and
this parameter changes accordingly to deterministic rule a = f(t, a
0
),
from an initial random state a
0
normally distributed,
then the time up to the parameter a reaches to critical value a
1
also
has a normal distribution.
Really, under described conditions the failure time is a solution of
f(T, a
0
) = a
1
.
Denoting by (a
1
, a
0
) the inverse function to f(t, a
0
), one get
T = (a
1
, a
0
).
Expanding the function (a
1
, a
0
) in the Tailor series with respect to
a
0
around the point a = Ma
0
up to second order members, one get
T = (a
1
, a) +
a
(a
1
, a)(a a
0
).
From here it follows that if parameter a
0
has a normal distribution,
then the failure epoch T also must be normally distributed. Moreover,
because the time to failure has only non negative values, the distribu-
tion should be truncated at zero.
The risk function for this distribution is
R(t) =
1
_
t
_
1
_
_
=
_
t
_
, t 0, (2.28)
where (x) =
1
2
x
_
u
2
2
du is the standard normal c.p.d. When (as
usually holds) << , thus it is possible to use an approximation
F(t) =
_
t
_
.
Expressions for the mean value and the variance of this distribution
are enough complicated, but for the usual sitiuation, when <<
they coincide with the parameters of normal distribution:
T
= MT =
2
T
= DT =
2
.
The c.d.f. of the distribution is presented at the gure 2.20
0
0.2
0.4
0.6
0.8
1
0.5 1 1.5 2 2.5
x
Figure 2.20. The c.d.f. for truncated normal distribution.
The h.r.f. is
(t) =
1
(t)
2
2
2
_
t
_ ,
and as it can be shown numerically has an asymptote y =
(t)
and
looks like as shown at the gure 5.2.8.
Figure 2.21. The hazard rate function for truncated normal law.
Example 5.2.8. Due to the h.r.f. property this distribution for
degradation modelling is used.
5.2.10. Almost-luck-of memory distributions
Some generalization of exponential family is so called family of Al-
most Luck of Memory (ALM) distributions. This family is used
for modelling periodic phenomenons in life and nature. Some examples
are:
(i) periodicity in sun activity;
(ii) periodicity of seasons in year, of ocean oods-ebbs, etc.;
(iii) many risk events, such as auto accidents, res, zunamis, epidemics,
pollution, etc.
We start with the dening the concept of lack-of-memory (LM) prop-
erty for random variables.
Denition 5.2.1. A non-degenerated at zero non-negative r.v. X
possesses the luck of memory (LM)-property at point c > 0 i
PX c + x [ X c = PX x
for all x 0. Naturally, it make sense only if 0 < PX c < 1.
Note also if this property holds for all possible values c of r.v. X, then
accordingly to the lemmas 5.1.1 and 5.2.1 this r.v. has or geometric,
or exponential distributions.
Lemma 5.2.1. If r.v. X possesses LM-property at the point c > 0,
then this property holds for all points of sequence
a
m
= mc
m=0
.
This means that the time axis can be divided into intervals
[0, c), [c, 2c), . . . , [mc, (m + 1)c), . . . ,
in which the r.v. is renewed.
The characterization property of the ALM distributions is
Theorem 5.2.2. Let r.v. X possesses of ALM property for se-
quence c
m
= mc
m=0
. Then
(i) for continuous X its p.d.f f
X
(x), x 0 is
f
X
(x) = (1 a)a
[x/c]
f
Y
(x [x/c]c), (2.29)
where a = PX c and f
Y
(.) is p.d.f. of some continuous r.v. Y at
nite interval [0, c);
(ii) for discrete r.v.X its distribution p
X
(x) is
p
X
(x) = (1 a)a
[x/c]
p
Y
(x [x/c]c), (2.30)
where the value a is the same as before, and p
Y
(.) is distribution of
some discrete r.v. Y with nite number of values 0, 1, . . . , c 1.
Another description of the ALM family convenient for simulation is

Theorem 5.2.3. A r.v. X possesses the ALM property at point c
and, therefore, for the sequence c
m
= mc
m=0
if and only if it can be
represented as a sum
X = Y
c
+ cZ (2.31)
of independent r.v.s Y
c
and Z, such that Y
c
is distributed at nite
segment [0, c), and Z has a geometric distribution
p
Z
(z) = (1 a)a
z
, z = 0, 1, . . . .
Most of these distributions can be used for modelling both the time
till to simple risk events and the damage them resulted.
In most risk situations the risk event (or risk process) is a result of
many dierent reasons. For these cases the models of compound
distributions are more applicable for time till risk evens as well as
for caused them damage. This class of distributions in the next section
will be considered.
Some parametric families of distributions jointly with their charac-
teristics are represented at the tables 5.2, 5.3.
Table 5.2. Reliability functions and their characteristics
Title Reliability
function
failure rate hazard rate mean value,
Variance
Exponential
e
t
e
t
1
,
1
2
Normal
_
t
_
e
(t)
2
2
2
2
_
_
e
(t)
2
2
2
2
_
t
_
,
2
Weibull-
Gnedenko e
t
t
1
e
t
t
1
_
1 +
1
_
1 +
2
2
_
1 +
1
Gamma
_

t
x
1
()
e
x
dx
(t)
1
()
e
t
(t)
1
e
t
_
t
x
1
e
x
dx
2
Lognormal
_
ln t
_
e
(ln t)
2
2
2
2t
e
(ln t)
2
2
2
2 t
_
ln t
_
e
(+
2
2
)
Reley
e
t
2
2
2
t
2
e
t
2
2
2
1
2
_
Uniform
1
b a
1
{atb}
b t
b a
1
{atb}
1
b t
1
{atb}
a + b
2
Power
1
_
1 +
t
1
1 +
_
t
_
+1
1
1 +
t
1
Table 5.3. Damage distributions and their characteristics
Title P.d.f. Mean value Variance
Uniform
1
b a
1
{axb}
,
0 a < b
a + b
2
(b a)
2
12
Shiftrd ex-
ponential e
(xb)
1
{xb}
,
b > 0, > 0
b +
1
2
Gamma
x
1
()
e
x
1
{x0}
,
> 0, > 0
2
Lognormal
1
2x
e
(ln x)
2
2
2
1
{x0}
,
> 0
e
+
2
2
_
e
2
1
_
e
2+
2
Pareto
c
_
c
x
_
+1
1
{xc}
,
c > 0, > 0
c
1
,
> 1
c
2
( 1)( 2)
,
> 2
Beta
(p + q)
(p) (q)
x
p1
(1x)
q1
1
{0x1}
,
p > 0, q > 0
p
p + q
pq
(p + q)
2
(p + q + 1)
5.3. Distributions with monotone hazard rate
The notion of hazard rate function was introduced in previous sec-
tion. Later some families of distributions will be studied based on the
properties of this function. For example constant h.r.f. characterized
exponential or geometric distributions. This allow to model time to
risk event arising with appropriate distributions if there exists some
theoretical bases to suppose that their h.r.f. is constant.
In other cases from some theoretical reasons ar based on statistical
observations one can suppose some special shape (form) of h.r.f. For
example the long-term observations of the peoples mortality show some
concrete shape of the h.r.f. for this phenomenon, which is shown at
the gure 5.3.1..
There exists an understandable treatment of this mortality rate be-
havior. Analogous behavior of h.r.f. is observed in another phenomena,
for example for aging units in reliability theory, where the h.r.f. for ag-
ing units increases with its age.
Figure 2.22. The mortality rate function.
5.4. Additions
Control questions
1. Examples.
2. Exercises.
6. Compound distributions
6.1. General properties
For complex risk situations modelling compound damage models are
usually used. These models are based on the following assumptions.
The whole damage Y are composed by the following values:
1. Fixed or random number N of risk events;
2. Corresponding damage values X
1
, X
2
, . . . , that are independent
r.v.s with given c.p.f. G
i
(x), (i = 1, 2, . . . ); sometimes (especially
in insurance models these values or groups of them might be supposed
identically distributed).
3. The r.v.s N and X
1
, X
2
, ... are usually supposed to be independent.
The r.v. N is called number of damages (claims). Its distri-
bution is completely described by the probability of k damages
p
k
= PN = k, k = 0, 1, 2, ...
In this case the whole damage Y is
Y =
_
0, if N=0,
X
1
+ X
2
+ ... + X
k
, if N=k=1,2,. . . .
(2.32)
Under assumption (3) for c.d.f. of whole damage Y one has
PY x =
k=0
PY x; N = k =
= P0 x, N = 0 +
k=1
PX
1
+ ... + X
k
x, N = k =
= PN = 01
{0x}
+
k=1
PX
1
+ ... + X
k
xPN = k,
where function 1
{x0}
is indicator function of a set x 0.
Denote by G
(k)
(x) the c.d.f. of the sum X
1
+... +X
k
of i.i.d. r.v.s,
G
(k)
(x) = PX
1
+ ... + X
k
x, k = 1, 2, 3, ...,
then for c.d.f. of whole damage Y (2.32) the following result holds
PY x = p
0
1
{x0}
+
k=1
p
k
G
(k)
(x), (2.33)
where index k is already not a random variable, but integer.
In the case if risk really exists, i.e. if p
0
< 1, then denoting by
p = 1 p
0
the probability of risk event, the damage distribution can
be represented in the form
PY x = (1 p)1
{x0}
+ p

G(x), (2.34)
where
G(x) =
k=1
p
k
p
G
k
(x) (2.35)
is a conditional damage distribution given risk event occurs.
The formulas (2.33 2.35) are the main points for the further inves-
tigations. The last one is very simple treated: with probability 1 p
the risk event does not occurs, in this case the damage equals to zero,
and with probability p risk event occurs and brings a damage with
distribution

G(x).
Because the calculations based on convolution (2.33) are often enough
dicult, the g.f. using (see 2) is more preferable. Practically, the con-
ditional damage distribution given risk event occurs, that is described
by formula (2.35), is more useful. Calculate its m.g.f.
g
Y
(s) = M[e
sY
[N 1] = (1 p
0
)
1
k=0
p
k
g
k
(s) =
p( g(s))
1 p
0
1.
(2.36)
6.2. Compound damages models
Denition 6.2.1. The distribution of the sum of random number
i.i.d. random summands is called by compound distribution
Consider some models of such distributions. They are sum of i.i.d.
r.v.s with appropriate distribution of number of components in the
sum.
6.2.1. Compound Poisson distribution.
This distribution is distribution of sum of i.i.d. r.v.s with Poissonien
number of summands. Accordingly to sect. 5.1.7 its m.g.f is
g
Y
(s) = e
(1 g(s))
.
Example 6.2.1. Let p
k
be Poisson distribution with mean >
0, i.e.
p
k
=

k
k!
e
, k = 0, 1, 2, ...
From the denition of p.g.f. it follows that
p(z) = e
(1z)
,
that gives the result above.
6.2.2. Compound geometric distribution.
This distribution is distribution of sum of i.i.d. r.v.s with Geometric
number of summands. Accordingly to sect 5.1.4 its m.g.f is
g
Y
(s) =
1 p
1 p g(s))
.
Calculate for example conditional (given risk event occurs) com-
pound geometric distribution with exponentially distributed summands
Example 6.2.2. Suppose that the initial damages X
i
exponentially
distributed with mean value
1
. Then accordingly to sect 5.1.4 taking
into account that the p.g.f. of geometric and the m.g.f. of exponential
distributions are
p(z) =
1 p
1 pz
and g(s) =

s +
the m.g.f. of this distribution can be given in form
g
Y
(s) =
p( g(s))
1 p
0
1 =
1
p
_
(1 p)(s + )
(s + p)
(1 p)
_
=
(1 p)
s + p
,
which is m.g.f. of exponential distribution with mean ((1 p))
1
.
Therefore, the whole conditional damage given risk event (with ge-
ometric number of damages with parameter p) occurs, being each in-
dividual damage exponentially distributed with parameter has the
exponential distribution with parameter (1 p).
6.2.3. Compound binomial distribution.
This distribution is distribution of sum of i.i.d. r.v.s with binomially
distributed number of summands. Accordingly to sect. 5.1.5 its m.g.f
is
g
Y
(s) = (1 p(1 g(s)))
n
.
6.2.4. Compound negative binomial distribution.
Analogously to the previous cases, accordingly to sect. 5.1.6 the
m.g.f. of this distribution is
g
Y
(s) =
_
(1 p)
1 p g(s)
_
.
Consider now the methods of the moments of compound distributions
calculation
6.3. Moments of compound damages
The using of g.f.s is the mostly convenient approach for the moments
of compound distributions calculation. Really, taking into account that
EY = g
Y
(0), EX = g
(0) and EN = p
(1)
one can nd
E[Y ] = g
Y
(0) = p
(1) g
(0) = E[N]E[X].
This means that
E[Y ] = E[N]E[X].
Further, using the relations
D[Y ] = E[Y
2
] (E[Y ])
2
= g
Y
(0) ( g
Y
(0))
2
,
g
Y
(0) = p
(1) g
(0) = E[N]E[X],
g
Y
(0) = p
(1)( g
(0))
2
+ p
(1) g
(0)
and
p
(1) = E[N
2
] E[N]
one can nd the variance of compound distribution
D[Y ] = g
Y
(0) ( g
Y
(0))
2
= p
(1)( g
(0))
2
+p
(1) g
(0) (p
(1) g
(0))
2
=
(E[N
2
] E[N] (E[N])
2
)(E[X])
2
+ E[N]E[X
2
] =
(E[N
2
] (E[N])
2
)(E[X])
2
+ E[N](E[X
2
] (E[X])
2
).
This means that
D[Y ] = D[X]E[N] + (E[X])
2
D[N]
In special case, when E[N] = D[N] (especially for Poisson distribu-
tion of N), the following formula takes place
D[Y ] = E[X
2
]E[N],
and in general case an evaluation holds
D[Y ] E[X
2
] maxE[N], D[N].
With the help of m.g.f. g
Y
(s) of compound distribution (??) it is
also possible to calculate the moments of the higher order. Especially
for third central moment with dierentiation one can get
g
Y
(0) = p
(1)[ g
(0)]
3
+ 3p
(1) g
(0) g
(0) + p
(1) g
(0).
Noting that
g
(0) = E[X], g
(0) = E[X
2
], g
(0) = E[X
3
],
p
(1) = E[N], p
(1) = E[N
2
] E[N],
p
(1) = E[N
3
] 3E[N
2
] + 2E[N]
taking into account that
E[Y
3
] = g
Y
(0)
and
E(Y E[Y ])
3
= E[Y
3
] 3E[Y ]E[Y
2
] + 2(E[Y ])
3
,
one can get the following relation
E(Y E[Y ])
3
= E(Y E[Y ])
3
E[N]+
+3D[N]D[Y ]E[Y ] + E(N E[N])
3
(E[Y ])
3
.
6.4. Additions
Control questions
Examples.
Example 1. Let p
(j)
k
, j = 1, n be Poisson distribution with
mean > 0. Calculate the distribution (convolution)
g = p
(1)
... p
(n)
Noting that p.g.f. of the distribution p
(j)
has a form
p
j
(z) = e
j
(1z)
.
and using part 2) of the theorem ?.2 for p.g.f. of the distribution g one
can get
g(z) =
n
j=1
p
j
(z) =
k
j=1
e
j
(1z)
,
i.e.
g(z) = e
(
1
+...+
k
)(1z)
.
From the part 1) of this theorem it follows that g is the Poisson distri-
bution with mean
1
+ ... +
k
.
Example 2. By using of the g.f. approach nd the m.g.f. of
compound damage. Let g
X
(s) be the m.g.f. of the initial damages X
i
values. Then acc. to the theorem 2.3.2 it follows
g
Y
(s) =
k=0
p
k
_
0
e
sx
g
(k)
(x) dx =
k=0
p
k
[ g
X
(s)]
k
.
Let
p(z) =
k=0
p
k
z
k
be the p.g.f. of the number N of damages, that is dened on the circle
[z[ 1 of a complex plane. Thus,
g
Y
(s) = p( g
X
(s)).
Exercises.
Bibliographical notes
7. Structural reliability
Because in engineering risk theory risk is caused by failure of a sys-
tem, we consider in this section the main approach to study a system
reliability. The main idea in reliability also as in risk theory consists
in studying a complex object by studying its component. In this sec-
tion, following to the book of Gertsbakh, 2000 [12], the reliability of a
complex system is studied in terms of reliability of its components,
which we usually call as elements.
7.1. Notion of structural function
Consider the system, constructed from n components, and denote
by x
i
(i = 1, n) indicator of i-th element state,
x
i
=
_
0, i-th element is down,
1, i-th element is up.
Denition 7.1.1. The structure function of a system is the
function, that shows the system state depending on the states of its
elements,
f(x
1
, ..., x
n
) =
_
0, if the system is down,
1, if the system is up.
For simplicity we will use the notations: x = (x
1
, ..., x
n
) and x < y
i x
i
y
i
for all i and for at least one component, say j, x
j
< y
j
.
Example 7.1.1. Series system. The series (in sense of reliabil-
ity) system is shown at the Fig 7.1.1. This system is up if and only if
all its elements are up. Therefore, its structure function is
f(x
1
, . . . , x
n
) =
n
i=1
x
i
. (2.37)
Fig 7.1.1. Series system
Example 7.1.2. Parallel system. The parallel (in sense of
reliability) system is shown at the Fig 7.1.2. This system is up if
and only if at least one of its elements is up. Therefore, its structure
function is
f(x
1
, . . . , x
n
) = 1
n
i=1
(1 x
i
) (2.38)
Fig 7.1.2. Parallel system
Example 7.1.3. k-out-of-n system. This system is up if and
only if at least k of its n elements are up. Its structural function is
f(x
1
, . . . , x
n
) =
_
1, when k from n units operate,
0, otherwise.
In special case, when n = 3, k = 2, which is shown at Fig. 7.1.3, the
structural function is
f(x
1
, x
2
, x
3
) = x
1
x
2
x
3
+ x
1
x
2
(1 x
3
) + x
1
(1 x
2
)x
3
+ (1 x
1
)x
2
x
3
(2.39)
Fig.7.1.3. Structure for 2-out-of-3 system.
Example 7.1.4. Cable TV transmitter. Consider the system
represented in the gure 7.1.4. It can be considered as a simple model
for Cable TV transmitter. There are central station S and three lo-
cal stations S
1
, S
2
, S
3
, that are connected with cables numbered with
1,2,3,4,5. The system is up if all substations are connected directly or
through another substations to the central one. It is possible to check
that
f(x) = 1 (1 x
2
x
3
x
5
)(1 x
2
x
4
x
5
)
(1 x
2
x
3
x
4
)(1 x
1
x
3
x
4
)(1 x
1
x
3
x
5
)(1 x
1
x
2
x
5
)(1 x
1
x
2
x
4
).
Fig. 7.1.4. Cable TV transmitter system.
7.2. Monotone structures
Denition 7.2.1. A system has monotone structure if
it is down when all its elements are down,
it is up when all its elements are up,
the state of whole system cannot become worse if any of its elements
change the state from down to up, and
all its elements are essential.
An element is non-essential for the system if the system structure
function does not depend on its state. In any case an element is called
essential for the system.
Formally, it is expressed with the help of two properties:
(i) f(0, . . . , 0) = 0, f(1, . . . , 1) = 1,
(ii) x < y implies f(x) f(y).
The above denition shows that all real systems are monotone.
Denition 7.2.2.
A state vector x is a cut vector if f(x) = 0.
The set C(x) = i : x
i
= 0 is then called a cut set.
If in addition, for any y with y > x f(y) = 1, then the correspond-
ing cut set is called minimal cut set.
A state vector x is called a path vector if f(x) = 1.
The set A(x) = i : x
i
= 1 is then called a path set.
If in addition, for any y with y < x f(y) = 0, then the correspond-
ing path set is called minimal path set.
A minimal cut set is a minimal set of components, whose failure
causes the failure of the whole system.
If all elements of the path set are up, then the system is up. A
minimal path is a minimal set of elements, whose functioning ensures
that the system is up. The minimal path set cannot be reduced, as it
has no redundant elements.
Now one important property of a structure function will be given.
Theorem 7.2.1. Let A
1
, . . . , A
s
be the set of minimal paths for
the system. Then
f(x) = 1
s
j=1
_
_
1
iA
j
x
i
_
_
(2.40)
Let C
1
, . . . , P
k
be the set of minimal cuts for the system. Then
f(x) =
k
j=1
_
_
1
iC
j
(1 x
i
)
_
_
(2.41)
Proof. If there exists at least one minimal path, say A
1
, all elements
of which are up, then
iA
1
x
i
= 1. It leads to f(x) = 1.
If the system is up. Then there must be at least one minimal path
having all of its elements in the up state. Thus, the right-hand side
of (2.40) is 1. Therefore f(x) = 1 if and only if there is at least one
minimal path having all its elements in the up state. This proves (2.40).
The proof of (2.41) is similar.
From this theorem it follows that any monotone system can be rep-
resented by two equivalent ways: as a series connection of parallel
subsystems each being a minimal cut set, or as a parallel connection
of series subsystems each being a minimal path set. Their structure
functions after corresponding simplication become identical.
It is necessary to remark, that in this form can appear some expres-
sions, that contains powers of some structural variables of the type
x
k
i
i
. Because for the binary variables the special rule holds: x
2
i
= x
i
,
therefore in simplied form one should omit all powers of structural
variables
To eliminate powers of structural variables it is possible to use so
called pivotal decomposition.
Denote by
(1
i
, x) = (x
1
, . . . , x
i1
, 1, x
i+1
, . . . , x
n
),
(0
i
, x) = (x
1
, . . . , x
i1
, 0, x
i+1
, . . . , x
n
).
The following theorem is simply checked by substitution of values
x
i
= 0 or x
i
= 1.
Theorem 7.2.2. It is true
f(x) = x
i
f(1
i
, x) + (1 x
i
)f(0
i
, x). (2.42)
By repeating the decomposition procedure one can represent any
structure function in the form
f
D
(x) =
a
f(a)
1in
x
a
i
i
(1 x
i
)
(1a
i
)
, (2.43)
which is known as a disjunctive normal form (DNF) of structural
function.
In Boolean algebra there exists a theorem, that any boolean function
can be reduced to the unique DNF.
Example 7.2.1.
Tor the bridge scheme the pivotal decomposition with respect to the
3-d elements gives
!!!
GIVE A PICTURE
!!!
f(x) = x
3
[1 (1 x
1
)(1 x
2
)][1 (1 x
4
)(1 x
5
)] +
+ (1 x
3
)[1 (1 x
1
x
4
)(1 x
2
x
5
)].
To check this decomposition one should to understand, that if 3-d
is up, the system became to be a series of parallel systems (1,2) and
(4,5), but if 3-d is down the system became to be a parallel of series
systems (1,4) and (2,5).
Exercise 1. By opining all parenthesis and calculation nd NDF
for this system.
Exercise 2. Obtain the same results with the methods of minimal
paths and minimal cuts.
7.3. Reliability of monotone system with independent
elements
Suppose now that the structural variables are binary r.v.s X
i
, that
takes values 1 and 0 with probabilities p
i
and q
i
= 1 p
i
,
p
i
= PX
i
= 1, q
i
= PX
i
= 0 = 1 p
i
.
This means that i-th element is up with probability p
i
and down with
probability q
i
. Because the whole system is up, when f(x) = 1, then
the whole system to be in up state is
p
f
= Pf(X
1
, . . . , X
n
) = 1 = Ef(X
1
, . . . , X
n
). (2.44)
The last expression is very useful for the system reliability calculation,
because of some special properties of expectation. Nevertheless, the
calculation of this value is not a simple problem, for which some special
methods and computer tools were elaborated.
Especially, for equiv-reliable elements, p
1
= p
2
= = p
n
= p for
the system reliability the following notation p
f
= h(p) will be used.
Consider now some examples of the reliability systems calculation
using their structure functions.
Example 7.3.1. Reliability of a series system. For the
series system (Fig 1.) the structure function is given by the formula
(2.37)
f(X
1
, . . . , X
n
) =
n
i=1
X
i
,
Therefore, accordingly to (2.40) the reliability of the system is
p
f
= h(p
1
, . . . , p
n
) = E
n
i=1
X
i
=
n
i=1
PX
i
= 1 =
n
i=1
p
i
, (2.45)
and for equiv-reliable elements it is
h(p) = p
n
. (2.46)
Example 7.3.2. Parallel connection. For the system with
parallel connected elements (Fig. 2), the structure function of which is
f(x
1
, . . . , x
n
) = 1
n
i=1
(1 x
i
)
the reliability of the system in accordance with (2.41) is
p
f
= h(p
1
, . . . , p
n
) = E[1
n
i=1
(1 X
i
)] = 1
n
i=1
E(1 X
i
) =
= 1
n
i=1
PX
i
= 0 = 1
n
i=1
(1 p
i
), (2.47)
and for eqiuv-reliable elements is
h(p) = 1 (1 p)
n
. (2.48)
By using the pivotal decomposition of the structural function (2.44)
one can nd
h(p) p
f
= p
i
f(1
i
, p) + (1 p
i
)f(0
i
, p) (2.49)
Proof. Due to independency of elements
h(p) = Ef(X) = E[X
i
f(1
i
, X)] + E[(1 X
i
)f(0
i
, X)] =
= p
i
f(1
i
, p) + (1 p
i
)f(0
i
, p).
In general, for the reliability of monotone systems with independent
elements the following theorem holds.
Theorem 7.3.1. The reliability of monotone systems with inde-
pendent elements equals to the value of DNF or linear form of structure
function, in which instead of structural variables their reliabilities sub-
stituted.
Proof. Using the DNF of structural function due to independency
of structural variables one has
p
f
= Ef
D
(X) =
a
f(a)E
_

1in
X
a
i
i
(1 X
i
)
(1a
i
)
_
=
=
a
f(a)
1in
E
_
X
a
i
i
(1 X
i
)
(1a
i
)
_
.
Because a
i
equals to 0 or 1, in the right-hand side one has
E
_
X
a
i
i
(1 X
i
)
(1a
i
)
_
= p
a
i
i
q
(1a
i
)
i
,
and therefore
p
f
=
a
f(a)
1in
E
_
X
a
i
i
(1 X
i
)
(1a
i
)
_
= f
D
(p). (2.50)
7.4. Reliability function for monotone systems
The above considerations, given for static reliability (before xed
time epoch), also applicable for dynamic (developed in time) reliabil-
ity. For this it is necessary only instead of static reliability of a system
elements to substitute their reliability functions. Especially, the relia-
bility function R
f
(t) of a system, constructed from n elements in series
r
i
(t) (i = 1, n) accordingly to (2.41) is
R
f
(t) =
n
i=1
r
i
(t).
Expressing the reliability functions in terms of its hazard rate functions
one can get
R
f
(t) = exp
_
t
0
f
(x) dx =
n
i=1
r
i
(t) = exp
_
t
0
n
i=1
i
(x) dx.
The very useful rule about h.r.f. for the system in series follows from
here
f
(t) =
n
i=1
i
(t).
This expression looks like more simple for unexpected failures, which
are characterized with constant h.r.f.,
f
=
n
i=1
i
.
In words for the system in series the system failure rate
equals to the sum of failure rate of its elements.
7.5. Additions
Example.
Consider the reliability of the system from Example 4.1.3 (see Fig.
4.1.3). The structure function of such system is
f(x
1
, x
2
, x
3
) = x
1
x
2
x
3
+x
1
x
2
(1 x
3
) +x
1
(1 x
2
)x
3
+ (1 x
1
)x
2
x
3
.
Therefore reliability of such system under assumption about equiv-
reliability of its elements is
h(p) = p
3
+ 3p
2
(1 p) = p
2
(3 2p).
Exercises
1. A system reliability scheme at the gure 7.5.1 is given. Find
structural function of the system and its reliability p
f
, if its elements
failure probabilities are: q
1
= 0, 05, q
2
= 0, 1.
Fig. 7.5.1. System reliability scheme for exercise 1.
Answer: p
f
= 1 [1 (1 q
1
)(1 q
2
)]
3
= 0, 997.
f
and the failure
probability q
f
, if its elements reliability are: p
1
= 0, 9, p
2
= 0, 8.
Answer: p
f
= [1(1p
1
)
3
][1(1p
2
)
3
] 0, 991, q
f
= 1p
f
=
0, 009.
f
and the failure
probability q
f
, if its elements failure probabilities are: q
1
= 0, 1, q
2
=
0, 2.
Answer: p
f
= (1 q
2
1
)(1 q
2
2
) = 0, 9216.
f
, if reliability
of its elements failure probabilities are: p
1
= 0, 9, p
2
= 0, 8, p
3
=
0, 85, p
4
= 0, 94.
Answer: p
f
= 1 (1 p
1
p
2
)(1 p
3
p
4
) 0, 944.
5. A system reliability scheme at the gure 7.5.5 is given. The
elements failure rates are constants and equal:
1
= 0, 3 10
3
(1/h),
2
= 0, 7 10
3
(1/h). Find value of the reliability function R
f
(t) p.d.f.
and h.r.f. of the system at time t = 100 hours and mean failure time.
Answer:
R
f
(t) = 1
_
1 e
(
1
+
2
)
_
2
; R
f
(100) = 0, 99;
f
=
3
2(
1
+
2
)
= 1500 (h.)
f
c
(t) = 2(
1
+
2
)e
(
1
+
2
)
_
1 e
(
1
+
2
)t
_
;
f
c
(100) = 1, 8 10
4
(1/h.);
c
(100) =
a(100)
P(100)
1, 8 10
4
(1/h).
6. A system reliability scheme at the gure 7.5.3 is given. Find value
of the reliability function R
f
(t) p.d.f. and h.r.f. of the system at time
t = 100 hours and mean failure time, if the elements failure rates are
constants and equal:
1
= 0, 3 10
3
(1/h),
2
= 0, 7 10
3
(1/h).
Answer: R
f
(t) =
_
1
_
1 e
1
t
_
2
__
1
_
1 e
2
t
_
2
_
;
R
f
(100) 0, 994;
f
=
4,5
(
1
+
2
)
2
_
1
2
1
+
2
+
1
1
+2
2
_
= 1760(hours);
f
c
(t) = 2e
(
1
+
2
)t
_
(
1
+
2
)(2 + e
(
1
+
2
)t
)
(2
1
+ )e
1
t
(
1
+ 2
2
)e
2
t
_
;
f
c
(100)
c
= 0, 108 10
3
(1/h.);
f
(100) =
a(100)
P(100)
1, 8 10
4
(1/h.).
8. Qualitative analysis
For reliability management it is important to know, how any element
reliability aects to the system reliability. Dierent types of elements
importance were considered by some authors.
8.1. Birnbaum index of element importance
Denition 8.1.1. Birnbaum importance of i-th element index
(B.i.i) B
i
(p) is
B
i
(p) =
h(p)
p
i
(2.51)
Due to pivotal decomposition (2.44)
f(x) = x
i
f(1
i
, x) + (1 x
i
)f(0
i
, x)
and the system reliability representation in the form
h
f
(p) = p
i
h
f
(1
i
, p) + (1 p
i
)h
f
(0
i
, p)
one has
B
i
(p) = h
f
(1
i
, p) h
f
(0
i
, p). (2.52)
The last equality shows that B.i.i. does not depend on i-th element
availability (stationary reliability), it has a property
1 B
i
(p) 1,
and can be interpret as a reliability of such a state that i-th component
failure leads to the system failure, so called i-th critical state.
Another interpretation can be done if instead of stationary we con-
sider time-dependent behavior of a system. In this case
dh(p(t))
dt
=
1in
h(p(t))
p
i
(t)
dp
i
(t)
dt
= B
i
(p(t))
1in
dp
i
(t)
dt
, (2.53)
that shows that the speed of the system reliability function decreasing
is the weighted sum of its elements speeds of reliability decreasing,
being B.i.i. its coecients.
Example 8.1.1. For series system
h(p) =
1in
p
i
and, therefore,
B
i
(p) =
1jn, j=i
p
j
.
Hence, if p
1
p
2
p
n
then B
1
(p) B
2
(p) B
n
(p).
Less reliable element more eect to the reliability of a system.
Example 8.1.2. For parallel system
h(p) = 1
1in
(1 p
i
)
and, therefore,
B
i
(p) =
1jn, j=i
(1 p
j
).
Hence, if p
1
p
2
p
n
then B
1
(p) B
2
(p) B
n
(p).
More reliable element more eect to the reliability of a system.
8.2. Barlow-Proshan index of element importance
Denote by Q(t) the total number of system failures in the interval
(0, t] and by Q
i
(t) the total number of system failures caused by the
i-th element failure in the sam interval.
Denition 8.2.1. Barlow-Proshan stationary importance
i-th element index (BP.i.i) is
BP
i
= lim
t
Q
i
(t)
Q(t)
. (2.54)
As it is clear from the denition this index shows the eect of i-th
element to the reliability of renewable system. For it calculation it is
possible to use the following theorem by Barlow, 1998 [3]
Theorem 8.2.1. It is true
BP
i
= lim
t
Q
i
(t)
1jn
Q
j
(t)
=
B
i
(p)
i
+
i
1jn
B
j
(p)
j
+
j
, (2.55)
where
j
and
j
are the mean value of j-th element being up and down.
There are some other indexes, which characterize elements impor-
tance for the system reliability. The problem is to generalize them in
order to take into account also the damages to characterize elements
failure importance for the system risk.
8.5. Additions
Control questions
Examples.
Exercises.
Chapter 3.
COLLECTIVE RISK THEORY (INSURANCE RISK THEORY)
The problem of damage modelling in insurance models is simplied a
little bit, because in these models instead of damage the claims, that
are at least partially specialized in the insurance contract, are usually
used.
9. The main notions and the problems formulation
In this section the main properties of collective risk models will be
considered and the main notions will be given.
The collective risk theory arisen in the entrails of insurance mathe-
matics and deals mainly with the ruin problems. The rst signicant
results in this directions were obtained by F. Lundberg, (1903) [17] and
H. Cramer, (1930, 1955) [5, 6].
CHAPTER 3. COLLECTIVE RISK THEORY (INSURANCE RISK THEORY) 196
9.1. Risk process and associate processes
In collective risk models instead of one risk event some consequence
of risk events in time risk process is considered.
(S
n
, X
n
) : n = 0, 1, 2, . . . , (3.1)
where S
n
are the epochs for the risk events, and X
n
are the sizes
of damages at these times.
Assumption 1. The existence of two rst moments of inter-arrival
times and the claim sizes is supposed,
E[S
n
S
n1
] < , D[S
n
S
n1
] < ;
EX
n
< , DX
n
< . (3.2)
A general mathematic model for such type of processes is a marked
point process.
Denition 9.1.1. A sequence of two-dimensional r.v. (3.1), rst of
which is a non decreasing sequence of real r.v., and the second one can
take any values, is called a marked point process, (MPP). The
rst components are known as points of the process, and the seconds
ones are called as marks of the process.
Remark. In general theory of MPP processes both components
can take values in general spaces. For example it is possible to con-
sider MPP in two dimensional space with marks in general measurable
space. For our goals it is enough to restricted ourselves with MPP in
real line with, may be, multidimensional marks.
There are several equivalent possibilities for this process describing,
for example as
a marked sequence of intervals between risk events
(T
n
, X
n
) : n = 0, 1, 2, . . . ,
where T
n
= S
n
S
n1
are intervals between risk events; or
a counting measure
N(t, B) =
n
1
{[0,t]B}
(S
n
, X
n
) t 0, B B,
which counts the number of events during time period t with the marks
from some set B.
Because these processes are functionally expressed one in terms of
another, then any of them could be used for description of the consid-
ered phenomenon. For concrete risk models these processes should be
specied.
The mostly important for collective risk study is the claim accu-
mulation process (c.a.p.). For its constructive description let us
introduce the risk events counting process,
N(t) =
n
1
{[0,t]}
(S
n
) = minn : S
n
> t.
Thus, the c.a.p. X = X(t), 0 can be represented as
X(t) =
N(t)
n=1
X
n
. (3.3)
For risk management it is necessary to have some nancial reserve in
order to satisfy the requirement claims. The claims compensation
process (c.c.p) Y = Y (t), t 0 also can be modelled as some
accumulating process,
Y (t) =
N
(t)
n=1
Y
n
,
where N
(t) is a counting process for reserves accumulation, and Y

n
are appropriate reserves accumulated at each time S
k
. However, in
insurance models the deterministic linear model for c.c.p.,
Y (t) = u + ct, (3.4)
is usually used, where positive constant c R
+
is called reserve
accumulation rate and u is an initial reserve (capital).
9.2. Reserve process
The collective risks models analysis really deals with the dierence
between c.c.p. and c.a.p., which we will refer to as a reserve process
Z(t) = u + ct
N(t)
k=1
X
k
,
_
0
k=1
X
k
def
= 0
_
, (3.5)
Namely this process is studied in the classic ruin model. However in
dierent applications, including insurance models, also another models
can be used.
Remark. Many authors refer to this process to as a risk process,
but we prefer to use for it more appropriate title.
Jointly with reserve process it is convenient also to consider two
closed to it processes: the income process
I(t) = ct X(t) (3.6)
and the claim surplus process (c.s.p.)
C(t) = I(t) = X(t) ct. (3.7)
6
-
t
C(t)
S
1
u
S
2
(u)(= S
3
)
@
@
@
@
@
.
.
.
@
@
@
@
@

@
@
@
@
@
@
.
.
.
.
.
.
.
.
.
.
.
.
@
@
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
Fig.9.1.1 Claim surplus process
In terms of these processes the reserve process can be expressed as
Z(t) = u + ct
N(t)
k=1
X
k
= u + I(t) = u C(t) = Y (t) X(t).
The random changes in reserve process occurs only in the claim ar-
rival epochs S
n
. Thus, it is also very useful and convenient to consider
this process just in these epochs. Denote Z(S
n
) = Z
n
and consider its
representation in terms of initial values.
Z
n
= Z(S
n
) = u + cS
n
N(t)
k=1
X
k
=
= Z
n1
+ cT
n
X
n
= Z
n1
V
n
, (3.8)
where V
n
is the increment of the c.s.p. or of the r.p. with sign minus
during n-th inter-arrival of claim period,
V
n
= X
n
cT
n
.
This representation is very useful for dierent special models of insur-
ance risk theory.
9.3. The ruin probability
One of the mostly important characteristics of collective risk models
is the ruin probability. There are two types of ruin probabilities at
nite and innite time intervals.
The ruin probability at nite time interval t with given
initial reserve u is
(t, u) = PZ(v) < 0 for given time v t, t > 0, (3.9)
while ruin probability at innite time interval or the prob-
ability of ultimate ruin with given initial reserve u is
(u) = PZ(t) < 0 for some time t > 0. (3.10)
Note that the initial condition Z(0) = 0 leads to the relation
(u) = 1 for u < 0.
Sometimes it is convenient to use an additional probability, which is
called non-ruin or survival probability
(u) = 1 (u). (3.11)
It is also possible to express these probabilities in terms of process
C(t). Let us also denote by T(u) the (random) time to ruin,
T(u) = inft : Z(t) < 0 = inft : I(t) < u =
= inft : C(t) > u. (3.12)
In terms of time to ruin the ruin probabilities can be represented also
in the form
(t, u) = PT(u) < t and (u) = lim
t
(t, u)
Because the ruin can occurs only at the claim arrival time it is also
useful to consider the number of claims K(u) to ruin occurs
K(u) = minn : Z(S
n
) < 0 = minn : I(S
n
) =< u =
= minn : C(S
n
) = X(S
n
) cS
n
> u. (3.13)
It is obvious that T(u) = S
K(u)
. Note that for this it is very important
to dene the reserve processes as continuous from the right.
There exists a relationship between innite-horizon ruin probabili-
ties of risk models in terms of continuous and discrete times. To nd
T(u) it is sucient to check the claim surplus process C(t) only at the
embedded epochs of claim arrival S
k
(see Fig. 9.2.1.).
6
-
t
C(t)
S
1
u
S
2
(u)(= S
3
)
@
@
@
@
@
.
.
.
@
@
@
@
@

@
@
@
@
@
@
.
.
.
.
.
.
.
.
.
.
.
.
@
@
.
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.
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.
.
.
.
.
Fig. 9.1.2 Claim surplus process
Indeed, denote V
k
= X
k
cT
k
, considering random walk W
n
=
V
1
+ + V
n
and put
M = sup
t0
C(t) = max
n0
1kn
V
k
= max
n0
W
n
. (3.14)
In terms of this r.v. the ruin probability reads
(u) = PM > u. (3.15)
This formula gives the possibility to treat the ruin probability function
(u) as the tail distribution of the stationary waiting time in a single
server queueing system (see below).
Moreover, let us consider the sequence of records of the random walk
W
n
. Beginning from
0
= 0 put
n+1
= minj >
n
: W
j
> W
n
, with
n+1
= if W
j
W
n
for all j >
n
.
= maxn :
n
< (3.16)
In general random walk theory they are called the sequence of as-
cending ladder epochs.
In this notation it is possible to rewrite the ruin probability in the
following way
M = max
n0
W
n
= max
n0
W
n
=
1k
(W
k
W
k1
) =
1k
W
+
k
,
(3.17)
where the notation W
+
k
= W
k
W
k1
is used. All these relations will
be used later for the ruin probability calculation for special models of
risk processes.
Remark. The notion of the ruin probability and appropriate mod-
els origins in mathematical insurance theory. Nevertheless, appropriate
model also successfully used in other applications such as storage the-
ory, models of water- and oil-reservoirs, etc.
9.4. Decit
For more detailed of the risk problem investigation it is also very
useful to consider the decit, which is the positive value of the reserve
process value at the rst ruin epoch.
D(u) = Z(T(u)) = Z
= Z
K(u)
. (3.18)
It is considered with sign minus in order to be positive.
6
-
t
C(t)
S
1
u
S
2
T(u)(= S
3
)
@
@
@
@
@
.
.
.
@
@
@
@
@

@
@
@
@
@
@
.
.
.
D(u)
_
.
.
.
.
.
.
.
.
.
@
@
.
.
.
.
.
.
.
.
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.
.
.
.
Fig.5.1.2 Decit and surplus prior to ruin
We consider some of these characteristics of collective risk theory for
dierent insurance models, and we start to study a ruin probability
problem in a simple discrete model of random walk.
9.5. Connection with Queueing theory
Consider a single-server QS with MPP input S
n
, X
n
: n = 1, 2, . . . ,
where S
n
are arrival epochs of jobs (demands, messages), and X
n
are
job size. If c is a service rate, then the workload process W(t) looks
like a c.s.p., and the sequence of time epochs
T
n+1
= inft : t > T
n
, W(t) = 0
is a sequence of the idle periods beginning. For workload process W(t)
at the job arrival times W
n
= W(S
n
) it holds
W
n
= [W
n1
+ X
n
cT
n
], n = 1, 2, . . . . (3.19)
Denoting V
n
= X
n
cT
n
from the last eq. with recursion it follows,
that
W
n
= max[0, V
n
, V
n1
+ V
n
, . . . W
0
+ V
1
+ + V
n
], n = 1, 2, . . . ,
(3.20)
which coincide with analogous relation for c.s.p.
9.6. Additions
Control questions
Examples
Exercises
W(t) =
_
_
W
0
=
1kN(t)
X
k
ct
_
_
10. Ruin problem for simple random walk model.
In this section we follow to the book of W.Feller, 1950 [11]
10.1. The ruin probability
Consider two gamblers who play a gamble, in which the rst gambler
win one unit (say dollar) with prob. p and the other with prob. q =
1 p. Considering the gamble from the position of the rst gambler,
suppose that the common their initial capital equals to a, and the
initial capital of the rst gambler equals to u 0 u a. Then acc.
to complete probabilities formula (CPF) the ruin probability (u) for
the rst gambler satises to the eq. (see Feller, 1950 [11])
(u) = p(u + 1) + q(u 1) (3.21)
with the boundary conditions
(0) = 1, (a) = 0. (3.22)
It is not dicult to show that the unique solution of the dierence
eq. (3.21) with the boundary cond. (3.22) is
(u) =
_
(q/p)
a
(q/p)
u
(q/p)
a
1
, if p ,= q,
1
u
a
, if p = q =
1
2
.
(3.23)
Remark 10.1. The probability of the rst gambler win (u) equals
to his adversarys ruin, and therefore can be obtained with replacing
of p, q and x by q, p and a x respectively. From here it follows as
a byproduct that
(u) + (u) = 1,
and, therefore, the innite gamble is impossible.
10.2. Expected duration of the game
The mean duration of the game will be done here by simple way, and
its generation function will be considered in the next section. Denote
by T(u) the time of the game duration and by (u) its expected value.
This value satises to the following eq.
(u) = p(u + 1) + q(u 1) + 1 for 0 < u < a (3.24)
(0) = 0, (a) = 0. (3.25)
This is non-homogeneous dierence eq. now, with an particular so-
lution
(u) =
u
q p
for p ,= q
Therefore, the general solution to the eq. (3.24) is
(u) =
u
q p
+ A + B
_
q
p
_
u
.
Finding the constants A and B from the boundary conditions (3.25)
one can get nally for the case p ,= q
(u) =
u
q p

a
q p
1 (q/p)
u
1 (q/p)
a
(3.26)
For the case p = q =
1
2
the particular solution to the eq. (3.24) is
(u) = u
2
and one can nd that its solution with boundary conditions (3.25) is
(u) = u(a u) (3.27)
10.3. Time to ruin
Denote the time to ruin distribution by
n
(u) = PT(u) = n.
The following eq. is a simple consequence of the CPF
n+1
(u) = p
n
(u + 1) + q
n
(u 1) (3.28)
n
(0) =
n
(a) = 0 for all n 1; (3.29)
0
(0) = 1,
u
(a) = 1 for u > 0. (3.30)
For the g.f.
(z; u) =
0k
k
(u)z
k
0 < u < a,
the eq. (3.28) has a form
(z; u) = pz(z; u + 1) + qz(z; u 1) (3.31)
and the boundary conditions (3.29, 3.30) takes form
(z; 0) = 1, (z; a) = 0. (3.32)
The systems (3.31) represents dierence eq., and the roots of appro-
priate characteristic eq.
(z) = pz
2
(z) + qz
are
1
(z) =
1 +
_
1 4pqz
2
2pz
,
2
(z) =
1
_
1 4pqz
2
2pz
(3.33)
Therefore, the general solution to (3.31) is
(z; u) = A
1
(z)
1
(z)
u
+ A
2
(z)
2
(z)
u
,
that after nding of the functions A
i
(z) from (3.32) is
(u) =
_
q
p
_
z
au
1
(z)
au
2
(z)
a
1
(z)
a
2
(z)
. (3.34)
This is m.g.f. for time to absorbtion at 0. The same argumentation
shows that the m.g.f. for time to absorbtion at a equals to
(u) =

u
1
(z)
u
2
(z)
a
1
(z)
a
2
(z)
. (3.35)
The m.g.f. for total time to ruin equals to the sum of these both.
10.4. Innite initial capital
Letting a in (3.23) with xed u one get formally
(u) =
_
_
_
1, if p = q,
_
q
p
_
u
, if p > q.
(3.36)
The value (u) in this case is interpreted as the probability of ultimate
ruin of a gambler with initial capital a playing against an innitely rich
adversary (Feller).
Remark 10.2. Strongly, the expression (3.36) should be nd as a
solution of the eq. (3.21) with only one boundary cond. (0) = 1, and
for the case p > q it is not unique.
The dierent type of asymptotic is also possible (see Exercises below).
9.6. Additions
Control questions
Examples
Exercises
Consider dierent type of the ruin probability asymptotic behavior
1. p < q
a) a , u , a u = c
b) a , u = a, a u = a(1 )
2. p > q
a) a , u , a u = c
b) a , u = a, a u = a(1 )
3. p = q =
1
2
a) a , u , a u = c
b) a , u = a, a u = a(1 )
11. Classic ruin problem
In this section a classic ruin problem in continuous time is presented.
11.1. Denitions. Assumptions
Consider reserve process Z = Z(t); t 0 under conditions that
the c.c.p. is a deterministic linear Y (t) = ct, and
a c.a.p. X = X(t); t 0 is a compound Poisson process, i.e.
N is a Poisson process, and X
k
1
is a sequence of i.i.d. r.v.
Denition 1. The process Z
Z(t) = u + ct X(t) (3.37)
under above assumption is called a classic reserve process or a
Poison model.
Remark 1. In the insurance literature the process Z is often called
by risk process. In the context of general risk theory and taking into
account the notion of engineering risks we prefer to safe the notion of
risk process for the point process S
k
, X
k
, k = 1, 2, . . . .
Remark 2. This process is a standard model for insurance compa-
nies, where N(t) is a number of insurance events in time interval (0, t],
and X
k
is a claim connected with k-th events. It is supposed that the
insurance premium represent a deterministic linear function with the
coecient c, which is called gross risk premium rate (norm).
Denote by
= E[X
k
] the mean value of the claims,

2
= D[X
k
] the variance of the claims, and
= E[N(1)] the intensity of the process N(t).
Accordingly to Assumption 1.
< ,
2
< (3.38)
The income of the company during the time interval (0, t] is I(t), and,
therefore, the mean income is
E[I(t)] = ct E[N(t)]E[X
k
] = (c )t.
It follows from LNL that for (c ) > 0 the income and reserve
processes diverges,
Z(t) +, with the probability 1 when t .
Let (u) is ruin probability with initial capital u,
(u) = Pu + I(t) < 0, for some t > 0. (3.39)
From another side it is clear that for c < mean income is less than
the mean summing claims, which means that the process decreases in
mean, and therefore the ruin probability equals to one. Due to chance
the same takes place for c = . Therefore the only the case c >
should be considered.
Assumption 2. Over this chapter it is supposed that
c > or =

c
< 1, =
c
> 0. (3.40)
Denition 11.2. The value is known as a relative safety
loading (r.s.l.).
To explain the generation of this value consider the reserve process
under the only net premium principle, which means, that c = .
This leads to risk process without drift, and, as it is known from general
Random Processes theory (or RW theory), this leads to unbounded
large uctuations of the process in time, and so ruin happens with
probability one. Adding a safety loading per unit of time = leads
to the reserve process with c = (1 + ), from which it is possible to
see that = .
11.2. Equations for the ruin probability
Instead of (u) it is more preferable here to consider the non-ruin
or survival probability
(u) = 1 (u).
It holds
Theorem 11.1. If c > , then the survival probability in classic
risk model satises to the integro-dierential equation
(u) =

c
(u)

c
_
u
0
(u y) dG(y). (3.41)
Proof. There are two approaches to deduce this equation.
First was proposed by H. Cramer (1930, p.75) and uses the Markov
property of the process Z.
The second one uses the decomposition to the rst attaintment for-
mula, and could be applied to more general model of Sparre Andersen,
and will be considered in the next section.
Accordingly to the rst approach consider the change of the process
Z(t) on a small time interval (0, ]. There are four non-joint events:
1) on (0, ] no one risk events arise,
2) on (0, ] one risk events arise, but the size of claim does not lead
to ruin,
3) on (0, ] one risk events arise, and the size of claim leads to ruin,
4) on (0, ] more than one risk events arise.
Suppose that the (u) is dierentiable. Then noting that the process
Z(t) has stationary independent increments, i.e. possesses of a Markov
property, with the help of the complete probability formula one can get
(u) = (1 + o())(u + c)+
+(+o())
u+c
_
0
(u +cz) dG(z) +(+o()) 0 +o()
= (1 )(u + c) +
u+c
_
0
(u + cz) dG(z) + o(),
where o() means that
o()
0 when 0.
From the last relation after some algebra and passing to limit when
0 the equation (3.41) follows.
Remark. To derive this equation by dierential method one
need to use an additional assumption about dierentiability of
the function (u) and a Poissonian property of the claim process. In
spite of strong substantiation of dierentiability of this function due to
Cramer (1955, pp. 60-61) we omit it, and in the next section we con-
sider another method for this equation deriving without this additional
supposition.
11.3. Analysis of the ruin probability
Let us go now to the above equation investigation.
Note, rst of all, that by dierentiation (see ex. 2) this equation is
reduced to the second order dierential equation, and, therefore, for its
solution two boundary conditions are needed.
To nd these conditions let us calculate the value of unknown ruin
probability for zero and innite initial capital.
First of all it is evident that for nite with probability one claims the
survival probability for innite initial capital equals to one, () = 1,
which gives the rst boundary condition.
To nd unknown probability (0) (the second boundary condition)
with integrating of the relation (3.41) over interval (0, t) one can nd
(t) (0) =

c
t
_
0
(u) du +

c
t
_
0
u
_
0
(u y)d(1 G(y)) du =
=

c
t
_
0
(u) du +

c
t
_
0
_
(0)(1 G(u)) (u) +
+
u
_
0
(u y) (1 G(y)) dy
_
du =
=

c
(0)
t
_
0
(1 G(u)) du +
+

c
t
_
0
(1 G(y)) dy
t
_
z
(u y) du =
=

c
(0)
t
_
0
(1 G(u)) du +
+

c
t
_
0
(1 G(y))((t y) (0)) dy =
=

c
t
_
0
(1 G(y))(t y) dy.
From this it follows
(t) = (0) +

c
t
_
0
(t y)(1 G(y)) dy. (3.42)
At least by passing in this relation to limit when t due to
monotone convergence one get
() = (0) +

c
().
From the rst boundary condition () = 1, one get
(0)) = 1

c
, (0)) = 1 (0) =

c
.
Denoting the constant by = (0)) =

c
, rewrite
(0) = =

c
, (0)) = 1 = 1

c
. (3.43)
Remark. In the QT interpretation the coecient is the load
coecient.
The best approach for the solution of the eq. (3.41) is to take its LT,
(s) =
_
0
e
su
(u), du.
Noting that the integral into this equation is a convolution type integral
one can nd
s
(s) (0) =

c
(s)

c
(s) g(s) =

c
(s)[1 g(s)].
Using the above notation the last relation can be represented in the
form
(s) =
1
s

c
(1 g(s))
. (3.44)
Represent this result as a corollary
Corollary. The LT of a survival probability has a form (3.44)
(s) =
1
s

c
(1 g(s))
.
Remark. Remind that this result is obtained under assumption
that c > or < 1 and note that it is unsensitive to the shape
of the claim distribution G(.) because the constant (0) =

c
=
depends on the claim distribution G only through it mean value.
It succeeds not often to nd the closed form for inverse LT of the
ruin (or survival) probability. In the further the asymptotic analysis
of the ruin probability will be proposed, but just now consider one
instructive example, when it is possible to inverse the formula (3.44)
in closed form.
Example 1. Exponential claim distribution. Consider a
simplest case, when the claim sizes X
k
is exponentially distributed
with mean value . In this case, LT of the exponential distribution is
g(s) =
1
1 + s
,
and therefore for

(s) from (3.44) it follows
(s) =
1
s

c
(1 g(s))
=
1
s

c
(1
1
1+s
)
=
(1 )(1 + s)
s(1 + s)
.
By decomposition on the simplest fraction and by passing to inverse
transform one can nd
(u) = 1 exp
_
u
_
,
or for the ruin probability
(u) = e
u
respectively.
Note that in this example the condition c > provide the existence
of the unique negative root
s
1
=
1
of the equation
s

c
(1 g(s)) = s
s
c(1 + s)
= s
_
1

1 + s
_
= 0.
The expression for the ruin probability in terms of it LT, as given
in (3.44) is not enough applicable in practice for risk analysis, which
needs in real evaluation of the ruin probability depending on time and
initial capital. In general case several approaches are possible for the
asymptotic of the ruin probability investigation.
Firstly it is possible to construct such an asymptotic by the way
of direct analysis of the inverse transform formula. In this case it is
necessary to take into account, that under condition (3.40) all roots of
the characteristic equation
s

c
(1 g(s)) = 0 (3.45)
belong to the left half-plane of complex variable s, and it is necessary
to investigate the singularities of this equation to nd an inverse LT.
Another approach deals with application of the renewal theory.
At least the third approach is based on the geometric sums of r.v.
investigation.
The rst approach was demonstrated in the Example above and we
touch some of these approaches in concrete examples.
Consider rstly an evaluation of the ruin probability under condi-
tion of a very quick (exponential) decreasing of the large damages
(claims), using the method, rstly proposed by Cramer, [6], and based
on the renewal theory methods.
11.4. The Cramer-Lundberg formula
Under condition c > transform the equation (3.42) to the form
1 (u) = 1

c
+

c
u
_
0
(1 (u x))(1 G(x)) dx =
= 1

c
_

u
_
0
(1 G(x)) dx +
u
_
0
(u x)(1 G(x)) dx
_
or
(u) =

c
_
u
(1 G(x)) dx +

c
u
_
0
(u x)(1 G(x)) dx. (3.46)
Note that this equation is a renewal equation type with respect to
the tail distribution with the p.d.f.
g(x) =
1 G(x)
and can be rewritten as or

(u) = (1

G(x)) +
u
_
0
(u x) g(x)) dx.
But for c > due to < 1 it is degenerate renewal equation and
the usual renewal theorem does not applicable in this case. Therefore,
following to Feller, 1971, p. 376, take the following
Assumption 3. Assume that there exist a positive constant R
such that
_
0
e
Rx
(1 G(x)) dx =
_
0
e
Rx
g(x) dx =
g(R) = 1. (3.47)
It is supposed the existence of real number r
> 0 such that

g(R)
+ for r r
. It is also possible that r
= +.
Remark. The main point in this assumption is

g(R) < for some
r > 0. This means that the tail of G(x) decreases exponentially. This
property does not take place for the heavy-tailed distributions such
that Lognormal or Pareto distributions.
By multiplying the last equation on e
Ru
one nd
e
Ru
(u) = e
Ru
(1

G(x)) +
+
u
_
0
e
R(ux)
(u x)e
Rx
g(x)) dx. (3.48)
Taking now into account that due to assumption A3 (3.47) the function
a(x) = e
Rx
g(x) (3.49)
is a p.d.f. of some probability distribution A, one get that the equation
(3.48) is a usual renewal equation. It follows from the renewal theory
that its solution has a form
e
Ru
(u) =
u
_
0
z(u x)dH(x),
where
z(u) = e
Ru
(1

G(x))
and H(u) is a renewal function, generated by a distribution A(.) with
the p.d.f. a(x) (3.49).
From the key renewal theorem it follows that there exists the limit
lim
u
e
Ru
(u) = a
1
_
0
z(u)du = K
CL
=
= a
1
_
0
e
Ru
(1

G(x)) du (3.50)
where K
CL
is Cramer-Lundberg constant, dened with last equa-
tion, and
a =
_
0
xe
Rx
g(x)) dx, (3.51)
is a mean value of the distribution A.
For the constant R calculation note that under assumption (3.47), it
follows that
g(R) = 1.
In terms of initial distribution G with the help of integrating by parts
one get
c
_
0
e
Rx
(1 G(x)) dx =
1
R
+
1
R
_
0
e
Rx
dG(x) =
1
R
+
1
R
g(R),
Therefore, the constant R (Lundberg coecient) is a positive so-
lution of the equations
g(r) = 1 +
cr
or
g(r) = 1, (3.52)
where g(s) and

g(s) are the m.g.f. for distribution G and

G corre-
spondingly. They are dened and analytical in all left half-plain of the
complex variable s and accordingly to the assumption (3.47) can be
continued to in its right part.
Taking into account that both of these functions are also completely
monotone, each of these equations under our main condition (3.40)
c > always have a unique positive solution (GIVE a PICURE)
From the last equation (3.50) the main result of this section follows
Theorem 11.2. Cramer-Lundberg approximation. The
ruin probability in classic ruin problem under assumptions 1-3 has a
form
(u) K
CL
e
Ru
, (3.53)
where the Cramer-Lundberg constant K
CL
is given by formula (3.51)
and the Lundberg coecient R is the eq. (3.52) solution.
For the constant K
CL
evaluation calculate rstly the integral in right
side part of the formula (3.50)
_
0
e
Ru
_
u
(1 G(x)) dx du =
_
0
x
_
0
e
Ru
(1 G(x)) dx du =

c
_
0
1
R
_
e
Rx
1
_
(1 G(x)) dx =
=

cR
_
0
(1 G(x)) dx +

cR
_
0
e
Rx
(1 G(x)) dx =
=
1
R
_
1

c
_
=
1
R
.
Here the rst equality is due to changing of the integration order, while
the second one follows from the assumption (3.47).
At least for calculation of the mean value a considering rstly the
function xe
Rx
as one in the integration by parts one has
x
_
0
ue
Ru
du =
1
R
__
x
1
R
_
e
Rx
+
1
R
_
,
and therefore
a =
_
0
xe
Rx
g(x) dx =
=

R
__
x
1
R
_
e
Rx
+
1
R
_
g(x)
0
+
+

R
_
0
__
x
1
R
_
e
Rx
+
1
R
_
dG(x)
=
=

R
_
0
__
x
1
R
_
e
Rx
+
1
R
_
dG(x) =
=

R
1 g(R)
R
+

R
_
0
xe
Rx
dG(x).
Now because
g
(R) =
_

0
xe
Rx
dG(x),
and
1 g(R) =
cR
from the last expression one can nd

a =

R
_
1 g(R)
R
+ g
(R)
_
=

cR
_
g
(R)
c
_
, (3.54)
and therefore,
K
CL
=
1
R
cR
_
g
(R)
c
=
1
c
g
(R) 1
=
c
g
(R) c
. (3.55)
From this result it follows that for large values of the initial capital
the ruin probability decreases with exponential rate.
(u)
c
g
(R) c
e
Ru
.
The last expression is known as the Kramer-Lundberg approx-
imation, and the coecient R in it as the Lundberg coecient.
Example 1 (Continuation). Let us turn to the example 1, and
analyze it with a new method. The LT of an exponential distribution
is
g(r) =
_

0
e
rx
e
x
dx =
1
1 r
and therefore the constant R is a positive solution of the equation
1
1 r
= 1 +
cr
,
i.e.
R =
1
_
1

c
_
=
1
.
Further.
g
(R) =

(1 R)
2
=

_
1
1
_
2
=

2
Therefore,
K
CL
=
c
g
(R) c
=
c
2
c
=
c
c c
=
This is not surprising that the Kramer-Lundberg approximation takes
place for exponentially distributed claims, and the result coincide with
the previously obtained with another approach.
In this section the second approach for investigation of the ruin prob-
ability, which deals with renewal theory application, was used. The
third one, which is based on the geometric sum application will be
used in last section for the ruin problem with heavy-tailed claim dis-
tributions investigation.
Remark. Instead of LT of the claim distribution some authors use
another characteristic that is closed to m.g.f. Namely,
h(r) =
_

0
e
rz
dG(z) 1.
In this case the assumption 3 looks like
11.6. Additions
Control questions
Examples
Exercises
1.
2. Show, that the equation (3.41) is reduced to the second order dif-
ferential equation
3. Show, that for innite initial capital the survival probability equals
to one, () = 1.
1.
2.
3.
4.
12. Sparre Andersen model
In this section the ruin problem is considered for the Sparre Ander-
sen continuous model, for which the capital accumulation follows as
before to deterministic linear model, and the claim process is general
cumulative process.
12.1. Denitions. Assumptions
Consider now the model of reserve process Z(t), in which the c.a.p.
Y (t) is also deterministic linear process Y (t) = ct, and the c.c.p. X(t)
is generated by a renewal process N(t) with i.i.d. claims. This mean
that the claim inter-arrival times
T
k
: k = 1, 2, . . .
are i.i.d. r.v.s with general c.d.f. F(t), and claims
X
k
: k = 1, 2, . . .
are also i.i.d. r.v.s with general c.d.f. G(t).
Theorem 12.1.1. Under A 1 (3.38) and the conditions c > ,
for Sparre Andersen model the following equation holds
(u) =
_
0
dF(s)
u+cs
_
0
(u + cs z) dG(z) ds. (3.56)
Proof. To prove let as suppose that S
1
is a rst claim epoch
occurrence. Because of ruin can not occur on interval (0, S
1
), and
Z(S
1
) = cS
1
X
1
one has
(u) = E[(u +cS
1
X
1
)] =
_
0
dF(s)
u+cs
_
0
(u +cs x) dG(x) ds,
that is coincide with (3.56)
Corollary. For exp. distributed claims the eq. (3.56) turns to
(u) =

c
e
u
c
_

u
e
s
c
_
x
0
(s y) dG(y) ds, (3.57)
which is coincide with (3.41).
Proof. With using F(s) = 1 e
s
and changing x = u + cs in
(3.56) one get
(u) =

c
e
u
c
_

u
e
x
c
_
x
0
(x y) dG(y) dx,
By dierentiation the last eq. transforms to
(u) =

c
(u)

c
u
_
0
(u y) dG(y),
that coincides with (3.41).
Unfortunately, the eq. (3.56) is usefulness for the SA model inves-
tigation except of that classic and, may be, some others simple cases.
Therefore in the next section another more useful approach will be
considered.
12.2. Discrete time model
Instead of continuous approach, which leads to the equation above,
it is more preferable to use a discrete time approach, which is based
on the random walk consideration. Because of the c > 0 the ruin can
occurs only at the claims occurrence epochs S
n
. Therefore, denote with
Z
n
the states of the reserve process at these epochs Z
n
= Z(S
n
) and
consider the increments V
n
of the claim surplus process (c.s.p.) during
the inter-occurrence claim epochs (which is coincide with Z
n
),
V
n
= (Z
n
Z
n1
) = X
n
c(S
n
S
n1
).
Obviously these r.v.s represent a sequence of i.i.d. r.v.s. The expected
loss between two claims epochs is
EV
n
= E[X
n
cS
n
] =
c
.
The relative safety loading (r.s.l.) equals
=
c
=
c
=
c
1 =
1
,
and the usual main assumption A2 (3.40) about positivity of the r.s.l.,
> 0, supposed to be hold.
From the denition of r.v.s V
n
for c.s.p. at claim occurrence epochs
C
n
holds
C
n
= W
n
=
1kn
V
k
for n = 1, 2, . . . and C
0
= 0. (3.58)
Denition 12.2.1. The sequence
W
0
= 0, W
n
= V
1
+ + V
n
, n = 1, 2, . . . (3.59)
is called random walk.
The following general Th. for RW holds (see [19], Th. 6.3.1., p. 233)
Theorem 12.4.1.
(a) If EV
k
> 0, then lim
n
W
n
=
(b) If EV
k
< 0, then lim
n
W
n
=
(c) If EV
k
= 0, then limsup
n
W
n
= , and liminf
n
W
n
=
Proof see in [19], p. 233.
Therefore, under our main assumption A1 (3.38) the random walk
W
n
has negative drift.
For the ruin probability (u), dened as usually by (3.9) it holds
(u) = Pmax
n1
C
n
> u.
Denote by the rst entrance time of the random walk W
n
into
the positive half-plane
=
_
minn > 0 : W
n
> 0,
if W
n
0 for all n = 1, 2, . . . .
(3.60)
This value is called the (rst) ascending ladder epoch (a.l.e) of
W
n
. Denote also the rst ascending ladder height (a.l.h.) H
with
H = C(S
) = X(S
) cS
1k
X
k
cS
. (3.61)
The rst descending ladder epoch
of W
n
is dened similarly.
In the gure below the rst ladder epochs and the ascending ladder
height H are depicted.
6
-
n
S
n

1 2 3 4(=
+
) 5
Y
+
Fig.6.3.2 Ascending ladder height

The following theorem holds
Theorem 12.4.2. (see [19], p. 235.)
The following statements are equivalent
(a) EV
k
< 0,
(b) M is nite with probability 1,
(c) H() < 1.
12.3. Renewal theory approach
Consider the ruin problem in terms of c.s.p. Because P < < 1
the r.v. H is a defective one. Denote by H(x) c.d.f. of H on the event
< ,
H(x) = PH
1
x, < .
Therefore,
(u) = P < = H(),
and the defect of H
1
represent the survival probability,
(u) = 1 H().
With the help of CPF one can get
(u) = H() H(u) +
u
_
0
(u x)dH(x), (3.62)
which is also as (3.46) a defective renewal equation.
Analogously to (3.47) take an additional
Assumption A4. There exists a constant R > 0 such that
_
0
e
Rx
dH(x) = 1. (3.63)
Then the equation also as (3.48)
e
Ru
(u) = e
Ru
(H()H(u))+
u
_
0
e
R(ux)
(ux)e
Rx
dH(x) (3.64)
is a proper renewal equation, and thus, accordingly to the renewal
theorem there exists a limit
lim
u
e
Ru
(u) =
J
1
J
2
, (3.65)
where acc. to the Assumption A4
J
1
=
_
0
e
Rx
(H() H(x))dx =
1 H()
R
,
and
J
2
=
_
0
xe
Rx
dH(x).
From the formula 3.65 the Cramer-Lundberg approximation follows
(u)
J
1
J
2
e
Ru
, (3.66)
where because R is the Lundberg exponent.
However this very interesting theoretical result is practically almost
useless, because its application needs in knowledge of the distribution
H(x), which is usually does not known explicitly.
Remark
In terms of QT the f.p.e. of the zero level by c.s.p. corresponds to
the time to the system to be free, and the interval to this time is a
busy period of the system.
Example 12.3.1. Exp. claim distributions.
For l.h. distribution holds
PH > x =
1k
PW
k
> x[W
k
> 0, T
k
, P = k,
where notation T
k
= W
k1
0, . . . , W
1
0 is used. For each
summands one has due to property of lack of memory of exp. distr.
PW
k
> x[W
k
> 0, T
k
=
PX
k
> x + cT
k
W
k1
[X
k
+ cT
x
W
k1
> 0, T
k
= e
(c/)
,
And therefore,
1 H(x) = PH > x =
1k
PX
k
> xP = k =
= e
(c/)
P < = pe
.
Calculating now J
1
one has
J
1
=
1 H()
R
=
1 p
R
,
where acc to (3.63) R is solution to
1 =
_
0
e
Rx
dH(x) =
p
_
0
e
Rx
e
dx =
p
1 R
.
At least
J
2
=
_
0
xe
Rx
dH(x) =

1 R
=

p
Substitution those values to (3.66) gives
(u) = pe
1p
u
.
12.4. Random walk approach
Consider also another approach, based on the investigation of ran-
dom sums of random variables. This approach will be also used in the
next section for the case about heavy tailed claim distribution investi-
gation.
Using the c.s.p. in the claim arrival consideration suppose that
E[V [ < and
PV = 0 < 1
To calculate the ruin probability using the connection between continuous-
time and discrete-time ruin problem formulation we enlarge the prob-
lem set and consider the claim surplus process after the rst ruin epochs
as its independent copies.
Analogously to the rst a.l.e. dene recursively further ladder epochs,
n+1
= minj >
n
: W
j
> W
n
,
0
= 0 and
1
= . (3.67)
It is not excluded that, from some random index , all the ladder epochs
are equal to .
The value
n
is called the n-th ladder epoch.
If < it is possible to consider the sequence
W
n
=
_
W
n
if
n
<
otherwise.
The elements of the sequence (
n
, W
n
W
n1
) forms the i.i.d. copies
of (, H). The sequence
H
n
=
_

W
n

W
n1
W
n
W
n1
if
n
<
otherwise
(3.68)
is called the sequence of ascending lader heights (a.l.h.) and it
constitute a new RW.
Because of P
H
n
= > 0 the new random walk

W
n
=

H
1
+ +

H
n
forms a terminating discrete-time renewal process, and the following

formula holds
M max0,

W
1
,

W
2
, . . .
.
=
1k
H
k
, (3.69)
where

N = maxn :
n
< is the number of nite ladder
epochs. Thus the following theorem holds, where the notation H
0
(x) =
H(x)/H() is used, and
H(x) = PH x P
H
k
x.
Theorem 12.4.3. [19], p. 236].
If EV < 0, then for all x 0 with the notation p = H() the
following relation is true
PM x = (1 p)
0k
H
(k)
(x) = (1 p)
0k
p
k
H
(k)
0
(x).
(3.70)
Proof.
Remind that due to H() < 1 the sequence

W
n
is a terminating
renewal process, and thus the the distribution of

N = maxn :
n
<
is geometric with parameter p,
P

N = k = (1 p)p
k
k = 0, 1, 2, . . . .
Thus, from (3.69) for the terminating renewal process it follows
PM x = P
_
_

0k
H
k
x
_
_
=
= (1 p)
0kle
p
k
H
(k)
0
(x) = (1 p)
0k
H
(k)
(x).
Taking into account that (u) = PM > u from this theorem one
can get
Corollary 12.4.1. For any u 0 holds
(u) = (1 p)
1k
p
k
(1 H
(k)
0
(x)). (3.71)
Unfortunately, the analytical calculation not for many models are
possible
Example 12.4.1. Exp. claim distr.
Using the previous results for l.h. distr H(x) one can nd that
1 H(x) =
p
and laplace transforming (3.71) one get
L
(s) = (1 p)
1k
_

(1 H)(s)
_
k
=
p(1 p)
1 p + s
= p
1
1 +

1p
s
.
Inverse transformation leads to
(u) = pe
1p
u
,
that coincide with the previous result.
13. The ruin problem for heavy-tailed claim distribu-
tions
In previous sections to provide an asymptotical analysis of ruin prob-
ability the main role plaid the Cramer assumption about behavior of
the tails of claim distributions. This assumption really require expo-
nentially quick decreasing of the claim distributions. Nevertheless, this
assumption is not valid for many distributions, such as, for example,
lognormal, Pareto and others. Because distributions of this sort arise
in many real applications, the problem of ruin probability study for
the distributions of this type are actual. This type distributions are
characterized with heavy tails. In this section a ruin problem for claims
with heavy-tailed distributions is considered.
In the present section the results for Sperre Anderson model with
heavy-tailed claim distributions are presented.
13.1. Denitions. Assumptions. Preliminaries
Remind
Denition 13.1.1. We will say that the distribution G(.) is a
heavy-tiled distribution if its m.g.f. g(s) = for all s > 0.
The lognormal, Pareto and Weibull with shape parameter < 1 are
some examples of such distributions. In actuarial science it is believed
that
lognormal distributions are plausible models for motor insurance,
while
Pareto distributions are apt to model re claim data.
It is not a very simple to recognize a heavy-tailed distribution. Some
properties and criterion to recognize of this class of distributions in the
Background were done.
Remind that V = X cT and denote V
+
= [X cT]
+
.
Firstly the following property of the i.t.d. F
(i)
V
+
of the r.v. V
+
will be
proved
Lemma 13.1. If i.t.d. of claim G
(i)
(x) is S-distribution, then i.t.d.
F
(i)
V
+
of V
+
is also an S-distribution, and
lim
x
1 F
(i)
V
+
(x)
1 G
(i)
(x)
=
EX
EV
+
. (3.72)
Proof. Since for all x 0 holds
F
V
+
(x) = PX cT x =
_

0
G(x + ct)dF(t)
it is true
1 F
V
+
=
_
0
[1 G(x + ct)]dF(t), x 0.
Thus, calculating the i.t.d. of F
V
+
by simple algebra it is possible to
nd
1 F
(i)
V
+
(x) =
1
EV
+
_
0
_

x
[1 G(y + ct)dydF(t) =
=
EX
EV
+
_
0
_

x
_
1 G(y + ct)
EX
_
dy dF(t) =
=
EX
EV
+
_
0
[1 G
(i)
(x + ct)]dF(t).
Divided the last expression by 1 G
(i)
(x) and taking into account the
property of i.t.d.s, that
lim
x
1 G
(i)
(x + ct)
1 G
(i)
(x)
= 1 for all t 0,
one can see that the property (3.73) is proved.
Now we should to show that subexponentiality of the i.t.d. G
(i)
of
claim sizes implies subexponentiality of the conditional ladder hight
distribution (l.h.d.) H
0
(x) use the denition of the previous section.
Lemma 13.1.2. If i.t.d. of claim G
(i)
(x) is S-distribution, then
the conditional l.h.d. H
0
(x) = p
1
H(x) with p = H() is also an
S-distribution, and
lim
x
1 F
(i)
V
+
(x)
1 H
0
(x)
=
p
EV
+
0
_
[t[dH
(t). (3.73)
Proof is used some special properties of Wiener-Hopf factorization
and it is omitted here
13.2. Approximations of ruin probability
The ruin probability behavior in models with heavy-tailed claim dis-
tribution is principally dierent. Namely it holds
Theorem 13.2.1. If G
(i)
(x) is an S-distribution, then
lim
u
(u)
1 G
i
(u)
=
EX
cET EX
=

c

=

c
=

1
. (3.74)
Proof. If G
(i)
(x) is an S-distribution, then acc. to the lemma 13.1.1
F
(i)
V
+
is also S-distribution, and acc to the lemma 13.1.2 the same is true
for H
0
(x) = p
1
H(x). On the other hand from (3.71) it follows
(u) = (1 p)
1k
p
k
(1 H
(k)
0
(x)).
and therefore
(u)
1 H
0
(x)
= (1 p)
1k
p
k
(1 H
(k)
0
(x))
1 H
0
(x)
.
Acc. to the property of S-distributions
lim
x
(1 H
(k)
0
(x))
1 H
0
(x)
= k,
and therefore
lim
x
(u)
1 H
0
(x)
= (1 p)
1k
kp
k
=
p
1 p
.
Further, using lemma 13.1.2 one can see
lim
x
(u)
1 G
i
(x)
= lim
x
_
1 F
(i)
V
+
(x)
1 G
(i)
(x)
1 H
0
(x)
1 F
(i)
V
+
(x)
(x)
1 H
0
(x)
_
=
=
EX
EV
+
EV
+
p
_
0
[t[dH
(t)
p
1 p
=
=
EX
(1 p)
_
0
[t[dH
(t)
.
Now to nd the value (1 p)
_
0
[t[dH
(t) we use some type of

Lindly equation
V (x) = H
+
(x) + H
(x) H
+
H
(x),
from which it follows
v(s) =

h
+
(s) +

h
(s)
h
+
(s)
(s),
and further
1 v(s) = (1
h
+
(s))(1
(s)).
With dividing the last expression by s and passing to limit when s 0
one nd
EV = EX cET = (1 H
+
())
_
0
[t[dH
(t)
and therefore
lim
x
(u)
1 G
i
(x)
=
EX
cET EX
=

c/
=

1
= .
Remark. Results of this theorem conrm the practical observation
about principally dierent reasons for ruin occurrence for light- and
heavy-tailed of the claims distribution: if in the rst case the ruin
occurs as a result of many claim accumulation, in the second one it
resulted only one large claim.
13.3. Examples
An Example 13.1.
The Weibull distribution
G(t) = 1 e
t
with shape parameter 0 < < 1 accordingly to criterion (RSST-p.60,

p.55) is an S-distributiom and therefore, acc. to Th. 13.2.1 for = 1
(u) =
1
_
u
e
t
_
u
e
y
y
1
1
dy, for u .
The left side hand of the last expression is an incomplete gamma func-
tion.
An Example 13.2.
Consider the Pareto distribution with p.d.f.
g(x) =

a
_
a
x
_
+1
1
{xa}
a > 0, > 1.
In this case, it is well known that = a/(1), and as it is possible
to show G
i
(x) is also S-distribution. Therefore,
(u) a
_
c( 1)
a
_
1
_
a
u
_
1
, when u .
An Example 13.3.
Let now G(x) be the lognormal distribution with parameters a
R, b > 0. It is possible to show rstly that
1 G
(i)
(x)
b
3
e
b
2
2
e
a
2
x
(ln x a)
2
exp
_
(ln x a)
2
2b
2
_
.
and therefore that G
(i)
(x) is an S-distribution. Applying the Th.
13.2.1. one has
(u) C
u
(ln u a)
2
exp
_
(ln u a)
2
2b
2
_
,
where C = b
3
_
1(c
)e
a+b
2
/2
_
1
.
13.4. Additions
Control questions
Examples
Exercises

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1

> 0. Therefore for each > 0 there exists x

and two rst moments are

p(p + ln(1 p))

has an exponential distribution. Appropriate c.d.f is presented at the

CHAPTER 2. INDIVIDUAL RISK MODELS (ENGINEERING RISK THEORY) 128

, when x , then 1 G(x) = e

Another description of the ALM family convenient for simulation is

(t) is a counting process for reserves accumulation, and Y

and can be rewritten as or

> 0 such that

. It is also possible that r

from the last expression one can nd

Fig.6.3.2 Ascending ladder height

forms a terminating discrete-time renewal process, and the following

and laplace transforming (3.71) one get

(t) we use some type of

with shape parameter 0 < < 1 accordingly to criterion (RSST-p.60,

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