Professional Documents
Culture Documents
(2013) 3:321–357
DOI 10.1007/s13385-013-0079-3
M. Mailhot (&)
Department of Mathematics and Statistics, Concordia University, Montreal, QC, Canada
e-mail: melina.mailhot@concordia.ca
M. Mesfioui
Département de mathématiques et informatique, Université du Québec à Trois-Rivières,
Trois-Rivières, Canada
123
322 H. Cossette et al.
Under the univariate hypothesis, several tools have been studied to measure risk and
allocate capital, especially for insurance companies and other financial institutions.
Value-at-risk (VaR) is an important risk measure in actuarial science and in finance
first because of regulatory reasons, but also because it is easy to understand. Let
X be a random variable (rv) with cumulative distribution function (cdf) FX. The
VaR, at level a, 0 \ a \ 1, of X is defined by
VaRa ðXÞ ¼ inffx 2 R; FX ðxÞ ag:
This risk measure is well understood and has been a point of interest for several
years. See e.g. McNeil et al. [21] for a review.
Some situations require that each component of a portfolio be fixed such that the
joint cdf does not to exceed a given level a. Notably, one may want to describe
relationships using inverse quantile functions, or allocate capital for each
component of a portfolio. As noted in Jouini et al. [16], investors might not be
able to aggregate their risks, due to liquidity problems and/or transaction costs
between the different security markets. In those situations, the use of a multivariate
VaR is more appropriate.
Embrechts and Puccetti [10] have introduced the multivariate lower and upper
orthant VaR associated to a loss X. Let X ¼ ðX1 ; . . .; Xk Þ be a random vector with joint
cdf FX and joint survival function (sf) FX : For a 2 ð0; 1Þ; the multivariate lower
orthant VaR at probability level a is the boundary of its a-level sets, defined by
VaRa ðXÞ ¼ o x 2 Rk : FX ðxÞ a : ð1:1Þ
Analogously, the multivariate upper orthant VaR at probability level a is given by
VaRa ðXÞ ¼ o x 2 Rk : FX ðxÞ 1 a : ð1:2Þ
The practical applications of these risk measures seem to be very promising,
especially in finance, quantitative risk management and actuarial science. As stated
in Cherubini and Luciano [5], one could be interested in a trade-off between the
VaR of two stock indices or in comparing a-level sets. Gugan and Hassani [14]
justify the use of multivariate risk measures by linking capital requirements with
operational risk capital, using pair-copulas. Frees and Valdez [13] consider the
bivariate allocation to losses and the related expense and adjustment costs. The
example in this paper has also been used in Di Bernardino et al. [8] to illustrate the
multivariate CTE presented in this article. The latter article studies the empirical
bivariate distributions of risks, and provide an estimation method for a multivariate
Conditional Tail Expectation. The applications of multivariate risk measures can be
used in other contexts than multivariate capital allocation or risk comparison, as for
studying reinsurance premiums and building asset portfolios.
Our objective is to study the behavior of VaRa (X) and VaRa (X) in a bivariate
setting to begin with. Results could be extended to higher dimensions (k [ 2) by, for
example, successively fixing each rv. Such an extension to a higher dimension will
be addressed in future work. Note that in certain contexts, such as vine copulas,
123
Bivariate lower and upper orthant value-at-risk 323
In this section, we propose an alternative way to define the lower and upper orthant
VaR, i.e. VaRa (X) and VaRa (X), defined in Embrechts and Puccetti [10].
Let X = (X1, X2) be a random vector with joint cdf FX and sf FX : Denote Fx1 and
Fx2 the marginal cdf’s of X. For fixed x1, define the functions x2 7! Fx1 ðx2 Þ ¼
FX ðx1 ; x2 Þ and x2 7! Fx1 ðx2 Þ ¼ FX ðx1 ; x2 Þ: Let Fx1
1
(a) and Fx1
1
ðaÞ be their corre-
sponding generalized inverse functions given by
Fx1
1
ðaÞ ¼ inf ft 2 R : Fx1 ðtÞ ag and Fx1
1
ðaÞ ¼ inf ft 2 R : Fx1 ðtÞ ag
respectively. Note that the inequality FX ðx1 ; x2 Þ a and FX ðx1 ; x2 Þ 1 a are
equivalent to x2 Fx1 1
ðaÞ and x2 Fx1
1
ð1 aÞ respectively. Moreover, if FX is
continuous, then we have
FX x1 ; Fx1
1
ðaÞ ¼ a; X x1 ; Fx1 ð1 aÞ ¼ 1 a; x1 VaRa ðX1 Þ:
F 1
123
324 H. Cossette et al.
VaRa ðXÞ ¼ x1 ; VaRa;x1 ðXÞ ; x1 VaRa ðX1 Þ ; ð2:1Þ
VaRa ðXÞ ¼ x1 ; VaRa;x1 ðXÞ ; x1 VaRa ðX1 Þ ð2:2Þ
and
VaRa ðXÞ ¼ VaRa;x2 ðXÞ; x2 ; x2 VaRa ðX2 Þ ; ð2:3Þ
VaRa ðXÞ ¼ VaRa;x2 ðXÞ; x2 ; x2 VaRa ðX2 Þ : ð2:4Þ
The latter approach defines the values obtained to represent the bivariate lower and
upper orthant VaR respectively, for X2 and X1. More precisely, (2.1) and (2.2) allow
to establish the lower and upper curves for X2, by fixing x1 and isolating x2. The
lower and upper curves for X1 are provided by (2.3) and (2.4). They are obtained by
fixing x2 and isolating x1. To simplify the presentation, we will systematically use
(2.1) and (2.2) to express our results.
Definitions (2.1) and (2.2) of the bivariate VaR allow us to derive the results
presented in this paper. We now investigate the behavior of the a-level curves
x1 7! VaRa;x1 ðXÞ and x1 7! VaRa;x1 ðXÞ: For that purpose, denote the supports of X1
and X2 by supp(X1) and supp(X2). Let lX1 and uX1 be the essential supremum and
essential infimum of X1 defined by lX1 ¼ inf fx : x 2 suppðX1 Þg and uX1 ¼
supfx : x 2 suppðX1 Þg; and define lX2 and uX2 for X2 similarly.
Proposition 2.1 Let X ¼ ðX1 ; X2 Þ be a pair of rv’s with joint cdf’s FX and
marginal cdf’s FX1 and FX2 . Then, the a-level curves
x1 7! VaRa;x1 ðXÞ and x1 7! VaRa;x1 ðXÞ
ð2Þ lim VaRa;x1 ðXÞ ¼ VaRa ðX2 Þ and lim VaRa;x1 ðXÞ ¼ lX2 : ð2:6Þ
x1 !lX1 x1 !VaRa ðX1 Þ
Given that FX is an increasing function (respectively FX decreasing), then one has
necessarily from (2.7) that x1 7! VaRa;x1 ðXÞ and x1 7! VaRa;x1 ðXÞ are decreasing
functions of x1 (if not, we have a contradiction). In addition, since FX is continuous,
then
lim VaRa;x1 ðXÞ ¼ FX1
2
ðaÞ ¼ VaRa ðX2 Þ:
x1 !uX1
123
Bivariate lower and upper orthant value-at-risk 325
In this section, we present analogous properties of the bivariate lower and upper
orthant VaR to those of the univariate VaR.
The following proposition states that the bivariate lower and upper orthant VaR
of a transformation of the bivariate set, through increasing functions, modifies the
curves by this same transformation. It also shows analogous results for decreasing
functions, where the bivariate lower (upper) orthant curve at level a, results in the
bivariate upper (lower) orthant at level 1 - a.
Proposition 2.5 Let X = (X1, X2) be a continuous random vector and
/ðXÞ ¼ ð/1 ðX1 Þ; /2 ðX2 ÞÞ;
where /1 and /2 are real functions defined on the supports of X1 and X2
respectively.
123
326 H. Cossette et al.
35
30
25
20
15
10
0
5 10 15 20 25 30 35
Fig. 1 Graphical representation of the bivariate lower and upper VaR. (a-curves of VaRa (X) (dashed)
and VaRa (X) (solid))
1 1
↑ θ=−5
0.9 VaRα(X2) θ=5
0.995
0.8
0.7
0.99
0.6
θ=−5
θ=5 VaRα(X1)→
0.5
0.985 ←VaRα(X1)
0.4
0.3 0.98
0.2
VaRα(X2)
0.1 0.975 ↓
0.5 0.55 0.6 0.65 0.7 0.75 0.8 0.85 0.9 0.95 1 0.99 0.991 0.992 0.993 0.994 0.995 0.996 0.997 0.998 0.999 1
Fig. 2 Graphical representation of the upper and lower orthant VaR with h = -5 and h = 5
123
Bivariate lower and upper orthant value-at-risk 327
Proof
1. Let us condition on X2 = x2 and consider increasing functions /i, i = 1, 2.
Then, one has VaRa;x2 7! Fx2 ðVaRa;x2 Þ such that
a ¼ FX ðVaRa;x2 ðXÞ; x2 Þ
¼ PðX1 VaRa;x2 ðXÞ; X2 x2 Þ
¼ Pð/1 ðX1 Þ /1 ðVaRa;x2 ðXÞÞ; /2 ðX2 Þ /2 ðx2 ÞÞ
¼ Pð/1 ðX1 Þ VaRa;/2 ðx2 Þ ð/ðXÞÞ; /2 ðX2 Þ /2 ðx2 ÞÞ:
Analogous arguments are used for a similar result with the bivariate upper orthant
VaR.
2. Let us condition on X2 = x2 and consider decreasing functions /i, i = 1, 2.
Then, one has VaRa;x2 7! F x2 ðVaRa;x2 Þ such that
1 a ¼ F X ðVaRa;x2 ðXÞ; x2 Þ;
and
1 a ¼ PðX1 [ VaR1a;x2 ðXÞ; X2 [ x2 Þ:
Because /i, i = 1, 2 are decreasing functions, one has
1 a ¼ Pð/1 ðX1 Þ /1 ðVaR1a;x2 ðXÞÞ; /2 ðX2 Þ /2 ðx2 ÞÞ
¼ Pð/1 ðX1 Þ VaRa;/2 ðx2 Þ ð/ðXÞÞ; /2 ðX2 Þ /2 ðx2 ÞÞ:
Analogous arguments are used for the result with the bivariate upper orthant
VaR. h
Corollary 2.6 ensures the translation invariance. For any additional risk to the set,
the curves will also translate for this same values c ¼ ðc1 ; c2 Þ 2 R:
Corollary 2.6 As a special case of Proposition 2.5, one has for all c ¼
ðc1 ; c2 Þ 2 R and i, j = 1, 2, i = j, then
VaRa;xj þcj ðX þ cÞ ¼ VaRa;xj ðXÞ þ ci ; VaRa;xj þcj ðX þ cÞ ¼ VaRa;xj ðXÞ þ ci :
Obtained with the application of Proposition 2.5 (item 1.), corollary 2.7 relates
the conditions for the bivariate lower and upper orthant VaR to be homogeneously
invariant. Through positive transformations of the bivariate set, the bivariate lower
and upper orthant VaR will vary with the same transformations, with level a.
Corollary 2.7 For all c ¼ ðc1 ; c2 Þ 2 Rþ Rþ and i, j = 1, 2, i = j, then
VaRa;cj xj ðcXÞ ¼ ci VaRa;xj ðXÞ; VaRa;cj xj ðcXÞ ¼ ci VaRa;xj ðXÞ:
Corollary 2.8 results from an application of Proposition 2.5 (2.), for negative
transformations of the bivariate set.
123
328 H. Cossette et al.
In this section, we want to study other properties of the bivariate lower and upper
orthant VaR and explain how to enlarge the use of the bivariate lower and upper
orthant VaR, by using confidence regions. The bivariate lower and upper confidence
regions of level a represents the sets of points covering a % of the possible values of
a bivariate set of rv’s. Those regions can represent an acceptance region as defined
in Jouini et al. [16] and Bentahar (2006), based on the bivariate VaR curves. The
bivariate lower orthant confidence region is bounded by a bivariate lower orthant
VaR, up to which a % of the sets are under that curve. The bivariate upper orthant
confidence region is bounded by the bivariate upper orthant VaR, up to which (1 -
a)% of the sets are over that curve.
Here and in the sequel, we denote CFX ;a ¼ ðx1 ; x2 Þ 2 R2 : FX ðx1 ; x2 Þ a and
CFX ;a ¼ ðx1 ; x2 Þ 2 R2 : FX ðx1 ; x2 Þ 1 a : In this section, we discuss how one
can derive a lower and upper confidence region based on the lower and upper
orthant VaR. The objective is to find a level curve such that the probability that the
random vector X is below (respectively above) this curve equals the level a.
To this end, define the bivariate order, denoted ; by X VaRa ðXÞ if and only if
X 2 CcFX ;a ; where CcFX ;a denotes the complement of the event CFX ;a : Clearly,
X VaRa ðXÞ is equivalent to X being below the curve VaRa ðXÞ: One has
PðX VaRa ðXÞÞ ¼ P X 2 CcFX ;a ¼ A1 þ A2
VaRa;s ðXÞ
Z1 Z
¼aþ f ðs; tÞdtds ¼ kðaÞ;
FX1 ðaÞ 1
1
ð2:10Þ
where f(s, t) denotes the joint probability density function (pdf) of random vector
X. Figure 3 illustrates
the regions A1 and A2 : Consequently, one has
P X VaRk1 ðaÞ ðXÞ ¼ a: In other words, the level curve VaRk1 ðaÞ ðXÞ can be
considered as a lower confidence region of the random vector X at level a.
Moreover, one observes that k1 : ½0; 1 7! ½0; 1 is an increasing function such that
k-1(a) B a. This means that the lower confidence region curve VaRk1 ðaÞ (X) is
smaller than the lower orthant a-level curve VaRa ðXÞ: Similarly, one can obtain the
upper confidence region of random vector X at level 1 - a, in terms of the upper
orthant VaR. In fact, let
be a bivariate order defined by X
VaRa ðXÞ if and only
if X is above the a-curve VaRa ðXÞ: It follows that
123
Bivariate lower and upper orthant value-at-risk 329
30
ψα(s)
A1
25
A2
20
15
t
10
5 → F−1
1
(α)
0
0 5 10 15 20 25 30 35
s
Fig. 3 Lower orthant confidence region for rv’s with positive supports
FX1 ðaÞ
Z1 Z1
P X
VaRa ðXÞ ¼ 1 a þ
f ðs; tÞdtds ¼ kðaÞ:
1 VaRa;s ðXÞ
The upper confidence region of random vector X is then given by VaRk1 ðaÞ ðXÞ; that
is,
P X
VaRk1 ðaÞ ðXÞ ¼ 1 a:
Hence, VaRk1 ðaÞ ðXÞ (respectively VaRk1 ðaÞ ðXÞ) can be viewed as a threshold curve
such that the probability that the components of the loss X over the given time
horizon are simultaneously below (respectively above) this curve with probability a
(respectively 1 - a).
Example 2.9 Let us consider the model chosen in Cherubini and Luciano [5] for
the returns on two different indexes, S&P100 and FTSE100 (historical data
downloaded from YahooFinance) represented by a Clayton copula (h = 0.5) and
normal marginal distributions. The copula allows to separate the impact on the joint
distribution of the marginal cdf’s. We use this example in order to illustrate the
confidence region at level 1 %, that could be of interest to study the effect of moving
capital from one desk to the other, using the trade-off of VaR. The confidence
bivariate lower orthant confidence region illustrates the 1 % acceptable scenarios,
for which trading from one desk to the other does not produce an undesirable
outcome. The same exercise could be done using portfolios of assets.
123
330 H. Cossette et al.
−3
x 10
log−returns of FTSE100
−5
−10
−15
−12 −10 −8 −6 −4 −2 0
−3
log−returns of S&P100 x 10
Figure 4 represents the trade-off curves at level 1 % and area under 0.535 % level
curve. It shows that 1 % of the sets under the bivariate lower orthant VaR at level
a = 1 % can be represented by the bivariate lower orthant VaR at level 0.535 %. h
As shown by Examples 2.2 and 2.4, the convexity of the joint cdf of X ¼ ðX1 ; X2 Þ
has an impact on the shape of the bivariate lower and upper orthant VaR. It will also
affect the allocation sets, when one wants to select a bivariate vector from the lower
or upper orthant VaR. This preoccupation is covered in Sect. 4.1 We need to study
the convexity of the curves first.
In what follows, we examine the shape of the a-level curves x1 7! VaRa;x1 ðXÞ and
x1 7! VaRa;x1 ðXÞ: The following result establishes sufficient conditions to ensure the
convexity and the concavity of these a-level curves.
Proposition 2.10 Let X ¼ ðX1 ; X2 Þ be a random vector with joint cdf FX and joint
sf FX : One has
(1) If FX is concave (respectively convex) then x1 7! VaRa;x1 ðXÞ is convex
(respectively concave).
(2) If FX is convex (respectively concave) then x1 7! VaRa;x1 ðXÞ is convex
(respectively concave).
Proof To show (1), suppose that FX is a concave function, with the confidence
region
123
Bivariate lower and upper orthant value-at-risk 331
CFX ;a ¼ ðx1 ; x2 Þ 2 R2 : FX ðx1 ; x2 Þ a
and let x ¼ ðx1 ; x2 Þ 2 CFX ;a ; y ¼ ðy1 ; y2 Þ 2 CFX ;a and k 2 ½0; 1: Then, one has
FX ðkx þ ð1 kÞyÞ kFX ðxÞ þ ð1 kÞFX ðyÞ ka þ ð1 kÞa ¼ a:
Thus, the confidence region CFX ;a is a convex set and its boundary is a convex
function, so x1 7! VaRa;x1 ðXÞ is convex. Now, if FX is convex, then the complement
of the confidence region CFX ;a is a convex set so the boundary of CFX ;a is concave,
thus (1) holds. Similar arguments may be used to show (2). h
We propose a practical criterion that ensures the convexity of these risk measures
and we set x1* = FX11 (a) and x2* = FX1
2
(a).
Proposition 2.11 Let X ¼ ðX1 ; X2 Þ be a random vector with joint cdf FX and joint
sf FX : Denote FX1 and FX2 the marginal cdf’s. Assume that FX is twice
differentiable. Then,
o2 FX
(1) If ox2i
ðx1 ; x2 Þ 0 for all x1 C x*1 and x2 C x*2, then the a-level curve
x1 7! VaRa;x1 ðXÞ is convex.
o2 FX
(2) If ox2i
ðx1 ; x2 Þ 0 for all x1 B x*1 and x2 B x*2, then the a-level curve
x1 7! VaRa;x1 ðXÞ is concave.
Proof Using implicit differentiable calculus rules, one deduces that VaRa;x1 ðXÞ is also
twice differentiable (because F is twice differentiable and FX ðx1 ; VaRa;x1 ðXÞÞ ¼ a).
Now using the fact that d2 FX x1 ; VaRa;x1 ðXÞ =dx21 ¼ 0; then
d d2 VaRa;x1 ðXÞ
FX x1 ; VaRa;x1 ðXÞ
dx2 dx21
d2 d2 dVaRa;x1 ðXÞ
¼ 2 FX x1 ; VaRa;x1 ðXÞ þ 2 FX x1 ; VaRa;x1 ðXÞ ð2:11Þ
dx1 dx1 dx2 dx1
d2 dVaRa;x1 ðXÞ 2
þ 2 FX x1 ; VaRa;x1 ðXÞ
dx2 dx1
hence (1), because
d 2 F X ðx 1 ; x2 Þ d dVaRa;x1 ðXÞ
0; FX ðx1 ; x2 Þ 0; 0:
dx1 dx2 dx2 dx1
The statement (2) is obtained similarly. h
Many bivariate distributions satisfy the criteria of Proposition 2.10, as for the
bivariate Eynaud–Farlie–Gumbel–Morgenstein (EFGM) bivariate exponential dis-
tribution, as presented in Balakrishnan and Lai [1].
Example 2.12 Consider the bivariate EFGM exponential distribution, with
parameters (b1 = 10, b2 = 15, h = 3). Figure 5 illustrates the curves of the
bivariate lower and upper orthant VaR at level 95 %, and for h = –0.9 and
123
332 H. Cossette et al.
100
θ=0.9
90 θ=−0.9
80
70
60
50
↑
40 VaRα(X2)
30
←VaRα(X1)
20
10
0
0 10 20 30 40 50 60
Fig. 5 Graphical representation of the lower and upper bounds with the bivariate FGM distribution, for
h = -0.9 and h = 0.9
h = 0.9. One sees that the bivariate lower orthant VaR is convex for h [ 0 and for
h \ 0. However, the bivariate upper orthant VaR is concave only when h [ 0,
which is a desirable scenario to obtain optimized values, as we will see further in
this chapter. The bivariate upper orthant VaR is convex when h \ 0. Moreover,
Fig. 5 clearly shows that the bivariate upper orthant VaR is more affected by
changes in the dependence parameter than the bivariate lower orthant VaR. h
As shown in Example 2.12, when there is a positive dependence between the
rv’s, the bivariate EFGM exponential distribution satisfies the two conditions of
Proposition 2.11, in order to have convenient lower and upper orthant VaR curves.
Note that the bivariate EFGM copula is generated from the bivariate EFGM
exponential distribution.
It is now well recognized that copulas provide a flexible approach to model the
joint behavior of rv’s. In fact, they allow the representation of a multivariate
distribution as a function of its univariate marginal cdf’s through a linking function
called a copula. Let X ¼ ðX1 ; X2 Þ be a random vector with joint cdf FX and marginal
cdf’s FX1 and FX2 . A well known theorem in Sklar [25] ensures that there exists a
unique copula C : ½0; 12 ! ½0; 1 such that for all x1 ; x2 2 R
FX ðx1 ; x2 Þ ¼ CðFX1 ðx1 Þ; FX2 ðx2 ÞÞ: ð2:12Þ
As a consequence of Proposition 2.11, the shape of the a-level curves
x1 7! VaRa;x1 ðXÞ and x1 7! VaRa;x1 ðXÞ may be studied in terms of copulas and
marginal cdf’s as stated next.
123
Bivariate lower and upper orthant value-at-risk 333
Corollary 2.13 Let X ¼ ðX1 ; X2 Þ be a random vector with joint cdf FX and
marginal cdf’s FX1 and FX2 connected by a copula C. Suppose that the copula C and
FXi , i = 1, 2 are twice differentiable.
o2 C
(1) If ou2i
ðu1 ; u2 Þ 0 for all u1 ; u2 2 ½a; 1; i ¼ 1; 2 and FX1 (x1) and FX2 (x2) are
concave for all x1 C x*1 and x2 C x*2, then the a-level curve x1 7! VaRa;x1 ðXÞ is
convex.
2
(2) If oouC2 ðu1 ; u2 Þ 0 for all u1 ; u2 2 ½0; a; i ¼ 1; 2 and FX1 (x1) and FX2 (x2) are
i
convex for all x1 B x*1 and x2 B x*2, then the a-level curve x1 7! VaRa;x1 ðXÞ is
concave.
Proof The result is immediate from Sklar’s theorem stated in (2.12). In fact, one
has
o2 F X o2 C
ðx ;
1 2x Þ ¼ ðFX1 ðx1 Þ; FX2 ðx2 ÞÞðFX0 i ðxi ÞÞ2
ox2i oFX2 i ðxi Þ
oC
þ 2 ðFX1 ðx1 Þ; FX2 ðx2 ÞÞFX00i ðxi Þ; i ¼ 1; 2; ð2:13Þ
oFXi ðxi Þ
123
334 H. Cossette et al.
In this section, we study the effect of the dependence level and the marginal cdf’s on
the bivariate upper and lower orthant VaR. Explicit bounds on these risk measures
are also obtained. In the following, we introduce stochastic ordering in order to
compare bivariate lower orthant VaR’s (respectively upper orthant VaR’s). The
latter is based on the confidence regions, presented in Sect. 2.3.
Definition 2.16 Let X1 = (X1,1, X2,1) and X2 = (X1,2, X2,2) be two pairs of risks
with joint cdf’s FX1 and FX2 ; respectively. Then, VaRa ðX1 Þ is smaller than
VaRa ðX2 Þ; denoted VaRa ðX1 Þ VaRa ðX2 Þ; if CFX2 ;a CFX1 ;a (equivalently
VaRa;x1 ðX1 Þ VaRa;x1 ðX2 Þ for all x1). Similarly, VaRa ðX1 Þ is smaller than
VaRa ðX2 Þ; denoted VaRa ðX1 Þ VaRa ðX2 Þ; if CFX2 ;a CFX1 ;a (or equivalently
VaRa;x1 ðX1 Þ VaRa;x1 ðX2 Þ for all x1).
123
Bivariate lower and upper orthant value-at-risk 335
Given two random vectors X1 = (X1,1, X2,1) and X2 = (X1,2, X2,2) with joint
cdf’s FX1 and FX2 respectively, X1 is said to be more concordant than X2, denoted
X1 co X2 ; if FX1 ðx1 ; x2 Þ FX2 ðx1 ; x2 Þ holds for all x1 ; x2 2 R:
It is easy to see that if X1 co X2 ; then CFX1 ;a CFX2 ;a and CFX2 ;a CFX1 ;a :
Moreover, if CX1 and CX2 denote the copulas of X1 and X2 respectively, then
X1 co X2 if and only if CX1 ðu; vÞ CX2 ðu; vÞ for all u; v 2 ½0; 1:
We define the Fréchet class, denoted by CðFX1 ; FX2 Þ; as the set of joint cdf’s FX1
with fixed marginals FX 1 and FX 2 . We also denote by
M(x1, x2) = min(FX1 (x1), FX2 (x2)) and W(x1, x2) = max(FX1 (x1) ? FX2 (x2) - 1, 0)
the Frchet upper and lower bounds respectively. It is well known that
Wðx1 ; x2 Þ FX ðx1 ; x2 Þ Mðx1 ; x2 Þ;
for all F 2 CðFX1 ; FX2 Þ and x1 ; x2 2 R:
The following result follows from the definition of the concordance ordering. It
shows the impact when the dependence structures within the vectors X1 and X2 are
different, but they have the same componentwise marginal cdf’s.
Lemma 2.17 (Impact of dependence) Let X1 = (X1,1, X2,1) and X2 = (X1,2, X2,2)
be two pairs of risks with joint cdf’s FX1 2 CðFX1 ; FX2 Þ and FX2 2 CðFX1 ; FX2 Þ;
respectively. Then, we have
X1 co X2 ) VaRa ðX2 Þ VaRa ðX1 Þ for all a 2 ½0; 1; ð2:14Þ
X1 co X2 ) VaRa ðX1 Þ VaRa ðX2 Þ for all a 2 ½0; 1: ð2:15Þ
Let us also discuss the effect of the marginal cdf’s on VaRa ðXÞ and VaRa ðXÞ
when the dependence between the components of X is fixed.
Lemma 2.18 (Impact of marginals) Let X1 = (X11, X21) and X2 = (X12, X22) be
continuous random vectors with the same copula C, within X1 and X2. Also,
consider the respective joint cdf’s FX1 2 CðFX1 ; FX2 Þ and FX2 2 CðGX1 ; GX2 Þ: Then,
for fixed a 2 ð0; 1Þ; we have
VaRa ðXi;1 Þ VaRa ðXi;2 Þ; i ¼ 1; 2 , VaRa ðX1 Þ VaRa ðX2 Þ; ð2:16Þ
VaRa ðXi;1 Þ VaRa ðXi;2 Þ; i ¼ 1; 2 , VaRa ðX1 Þ VaRa ðX2 Þ: ð2:17Þ
Proof To verify ()) in (2.16) and (2.17), we use the fact that if VaRa(X-
i,1) B VaRa(Xi,2), i = 1, 2, then C FX1 ;a C FX2 ;a and C FX1 ;a C FX2 ;a : To show (()
lim VaRx1 ;a ðX1 Þ ¼ VaRa ðX1;1 Þ; lim VaRx1 ;a ðX2 Þ ¼ VaRa ðX1;2 Þ; ð2:18Þ
x1 !1 x1 !1
lim VaR1
x2 ;a ðX1 Þ ¼ VaRa ðX2;1 Þ; lim VaR1
x2 ;a ðX2 Þ ¼ VaRa ðX2;2 Þ: ð2:19Þ
x2 !1 x2 !1
Now, VaRa ðX1 Þ VaRa ðX2 Þ implies VaRx1 ;a ðX1 Þ VaRx1 ;a ðX2 Þ and
VaRx2 ;a ðX1 Þ VaR1
1
x2 ;a ðX2 Þ: Thus, from (2.18) and (2.19), we have
123
336 H. Cossette et al.
In this section, we motivate the use of bivariate VaR’s to obtain accurate values for
risk allocation and comparison, in the case of sum of random pairs. Models should
try to capture important characteristics such as the marginal cdf’s of homogeneous
classes and the appropriate dependence structure between classes. Using bivariate
VaR’s allows to consider each homogeneous structure of a dependent set during the
modeling process. We initiate this section by setting the framework.
Let X1 ¼ ðX1;1 ; X1;2 Þ; . . .; Xn ¼ ðXn;1 ; Xn;2 Þ be a sequence of n random pairs with
distributions FX1 ; . . .; FXn and marginal cdf’s FX1;1 ; . . .; FXn;1 and FX1;2 ; . . .; FXn;2 :
Denote S1 ¼ X1;1 þ þ Xn;1 and S2 ¼ X1;2 þ þ Xn;2 : In this section, we
examine the lower and upper orthant VaR of the random vector. We have S ¼
X1 þ þ Xn ; where
S1 X11 ... Xn1
S¼ ¼ þ þ ;
S2 X12 ... Xn2
and where X1 ; . . .; Xn are linked by a copula C. The computation of the joint cdf of
S is not obvious even for specific dependence structures assumed for the random
vectors X1 ; . . .; Xn : Therefore, it is not easy to evaluate the univariate VaR for sums
of random variables. The problem is even more challenging when considering
bivariate sums of random pairs.
123
Bivariate lower and upper orthant value-at-risk 337
In Sect. 3.1 we study the sum of random vectors with comonotonic components. In
Sect. 3.2, we develop bounds on the bivariate lower and upper orthant VaR for pairs
representing random sums, in terms of the univariate VaR. We also establish the
relation with existing stochastic bounds. In Sect. 3.3, we provide bounds for the sum
of a bivariate set, where each component represents aggregated homogeneous risks.
X
n
VaRa;sj ðSÞ ¼ VaRa;xk;j ðXk Þ; sj VaRa ðSj Þ; ð3:2Þ
k¼1
P n Pn 1
Pn
where k=1 xk,j = sj = k=1Fxk;j FSj (sj) and FS1
FX1 j
k;j
(u) =
(u), j = 1, 2.
k=1
P n
Proof Using the fact that S ¼ ðS1 ; S2 Þ ¼ ðFS1 ðU1 Þ; FS1 ðU2 ÞÞ and k=1
Pn 1 1 2
xk,j = sj = k=1FXk;j FSj (sj), then from Proposition 2.5, we have for i, j = 1, 2
and i = j,
VaRa;sj ðSÞ ¼ VaRa;sj ðFS11
ðU1 Þ; FS12
ðU2 ÞÞ
1
¼ FSi VaRa;FSj ðsj Þ ðU1 ; U2 Þ
Xn
¼ FX1k;i VaRa;FSj ðsj Þ ðU1 ; U2 Þ
k¼1
X
n
¼ FX1k;i 1 1
VaRa;FX1 ðFSj ðsj ÞÞ ðFXk;1 ðU1 Þ; FXk;2 ðU2 ÞÞ
k;j
k¼1
Xn
¼ VaRa;xk;j ðFX1k;1 ðU1 Þ; FX1k;2 ðU2 ÞÞ
k¼1
Xn
¼ VaRa;xk;j ðXk Þ:
k¼1
123
338 H. Cossette et al.
3.2 Bounds on the bivariate lower and upper orthant value-at-risk for sums
of random pairs
Now, let us examine bounds on VaRa;si ðSÞ and VaRa;si ðSÞ; i ¼ 1; 2: We link
univariate and multivariate results using the bivariate lower and upper orthant VaR
and stochastic bounds for FSi , i = 1, 2. It allows to take into account homogeneous
groups of risks, part of a global dependent set. One can easily derive the following
bounds on the a-level curves si 7! VaRa;si ðSÞ and si 7! VaRa;si ðSÞ in terms of
VaRa(Si) and FSi :
VaRa ðSj Þ VaRa;si ðSÞ VaRaFSi ðsi Þþ1 ðSj Þ; si VaRa ðSi Þ; ð3:3Þ
VaRaFSi ðsi Þ ðSj Þ VaRa;si ðSÞ VaRa ðSj Þ; si VaRa ðSi Þ; ð3:4Þ
for i, j = 1, 2, i = j.
It is not easy to evaluate explicitly VaRa(Si) and FSi , i = 1, 2. However, several
authors have examined explicit formulas and the estimation of these quantities by
deriving stochastic bounds on the distribution of Si, i = 1, 2. Makarov [20] and
independently Rschendorf (1982) obtained stochastic bounds on FSi , i = 1, 2.
Williamson and Downs [26] also studied stochastic bounds and extended previous
results, using the duality principle. Denuit et al. [7] applied the stochastic bounds in
actuarial science, applying their results to insurance problems. Embrechts and
Puccetti [11] uses stochastic bounds on FSi , i = 1, 2 to improve the results obtained
in Embrechts et al. [9]. To recall these results, let Ci be the copula associated to the
rv’s X1;i ; . . .; Xn;i ; i ¼ 1; 2: Denote by Cdi the dual of Ci, i = 1, 2 defined by
!
[
n
Cid ðu1;i ; . . .; un;i Þ ¼ P Uj;i uj;i ; i ¼ 1; 2;
j¼1
where ðU1;i ; . . .; Un;i Þ denotes a random vector with distribution Ci, i = 1, 2. It will
be supposed, however, that partial information is available about Ci, namely that
there are copulas Ci,L and Ci,U such that Ci C Ci,L and Cdi B Cdi,U, i = 1, 2.
Any multivariate distribution function can be represented in a way that
emphasizes the separate roles of the marginal cdf’s and the dependence structure.
For all s 2 R; Fmin;Si ðsÞ FSi ðsÞ Fmax;Si ðsÞ such that
Fmin;Si ðsÞ ¼ sup Ci;L F1;i ðu1 Þ; . . .; Fn;i ðun Þ ; i ¼ 1; 2; ð3:5Þ
u1 þþun ¼s
d
Fmax;Si ðsÞ ¼ inf Ci;U F1;i ðu1 Þ; . . .; Fn;i ðun Þ ; i ¼ 1; 2: ð3:6Þ
u1 þþun ¼s
Williamson and Downs [26] presented bounds for the VaR of the sum of two risks
123
Bivariate lower and upper orthant value-at-risk 339
using the duality principle. The n-dimensional formulation of this result is stated
formally by
X
n
1
VaRmin;a ðSi Þ ¼ sup Fj;i ðuj Þ; i ¼ 1; 2; ð3:7Þ
d ðu ;...;u Þ¼a
Ci;U 1 n j¼1
X
n
1
VaRmax;a ðSi Þ ¼ inf Fj;i ðuj Þ; i ¼ 1; 2: ð3:8Þ
Ci;L ðu1 ;...;un Þ¼a
j¼1
This is in fact a special case of Theorem 3.1 of Embrechts et al. [9], where the VaR
of a function wðx1 ; . . .; xn Þ of n-dependent risks was treated, applying the duality
principle of Frank and Schweizer [12].
In practical situations, the dependence structure of ðX1i ; . . .; Xni Þ; i ¼ 1; 2 is often
unknown. However, for any copula, the inequalities Ci C W and Cid W ~ d hold,
where
Wðu1 ; . . .; un Þ ¼ minðu1 þ þ un 1; 0Þ and
W~ d ðu1 ; . . .; un Þ ¼ minð1; u1 þ þ un Þ:
~ d and W respec-
Practical bounds can be obtained by replacing Cdi,U and Ci,L by W
tively in (3.7) and (3.8).
Proposition 3.2 We obtain bounds for the lower and upper orthant VaR, using
bounds on the univariate VaR, that is
1
VaRmin;a ðS2 Þ VaRa;s1 ðSÞ VaRmax;aFmin;S1 ðs1 Þþ1 ðS2 Þ; s1 Fmin;S 1
ðaÞ; ð3:9Þ
and
1
VaRmin;aFmax;S1 ðs1 Þ ðS2 Þ VaRa;s1 ðSÞ VaRmax;a ðS2 Þ; s1 Fmax;S1
ðaÞ: ð3:10Þ
123
340 H. Cossette et al.
Also, we provide results when the dependence structures between and within the
classes of risks are known or not.
Consider a portfolio divided into two classes comprising n1 and n2 contracts, and
let Xi,j represent the risk associated to the ith contract in the jth class, j = 1, 2. In
many situations, it is convenient to model separately the distribution of each random
vector X1 ¼ ðX1;1 ; . . .; Xn1 ;1 Þ and X2 ¼ ðX1;2 ; . . .; Xn2 ;2 Þ instead of the distribution of
the random vector X ¼ ðX1;1 ; . . .; Xn1 ;1 ; X1;2 ; . . .; Xn2 ;2 Þ: This is because the classes
are often homogeneous, and it can be easier to identify the structure of each vectors
X1 and X2 instead of the structure of the random vector X. In such a case, the lower
and upper orthant VaR can be used to derive bounds on VaR(S1 ? S2), for example,
instead of modeling the aggregate distribution of all the risks.
Corollary 3.3 When the structure of dependence of (S1, S2) is known, one obtains
( )
max s1 þ VaRa;s1 ðSÞg VaRa ðS1 þ S2 Þ min fs1 þ VaRa;s1 ðSÞ :
s1 \FS1 ðaÞ s1 [ FS1 ðaÞ
1 1
ð3:11Þ
When the structure of the dependence of the random vector (S1, S2) is unknown, one
can use Proposition 3.2 to derive bounds on VaRa(S1 ? S2) that are expressed in
terms of the bounds on the cdf’s of S1 and S2 as shown next:
Amin max
a VaRa ðS1 þ S2 Þ Aa ;
where
Amin
a ¼ max fs1 þ FS1
2
ða FS1 ðs1 ÞÞg and
s1 \FS1 ðaÞ
1
Amax
a ¼ min fs1 þ FS1
2
ða FS1 ðs1 Þ þ 1Þg:
s1 [ FS1 ðaÞ
1
where
n o
1
Dmin
a ¼ max s1 þ Fmin;S2
ða Fmax;S1 ðs1 ÞÞ
1
s1 \Fmin;S ðaÞ
1
and
n o
1
Dmax
a ¼ min s1 þ Fmax;S 2
ða F min;S 1
ðs1 Þ þ 1Þ :
1
s1 [ Fmin;S ðaÞ
1
We want to highlight the fact that using our approach to provide bounds on the
lower and upper orthant VaR gives the opportunity to consider the dependence
within different sectors X1 and X2, and also to consider the model that represents the
dependence between sectors. Traditional methods consider a different dependence
123
Bivariate lower and upper orthant value-at-risk 341
structure, that is possibly hard to fit, because they consider heterogeneous variables,
which is not the case in Eqs. (3.7) and (3.8). This method leaves aside the depen-
dence within and between X1 and X2.
For illustration, let us consider the case where X1;i ; . . .; Xn;i are identically
distributed with common cdf FXi ; i ¼ 1; 2: Suppose that there exists x
i 2 R such that
the density function fXi ðxÞ ¼ dFXi ðxÞ=dx is non-increasing for all x x
i ; i ¼ 1; 2:
This assumption is fulfilled for many important models in actuarial science and
quantitative risk management like exponential, Pareto and gamma models. Suppose
also that X1;i ; . . .; Xn;i ; i ¼ 1; 2 are positively lower orthant dependent (PLOD).
Then, from Remark 3.2 in Mesfioui and Quessy [22] we have
VaRmax;a ðS2 Þ ¼ nFX12 a1=n ; Fmin;S1 ðs1 Þ ¼ ½FX1 ðs1 =nÞn : ð3:12Þ
Combining (3.9) and (3.12), we get the next explicit upper bound of VaRa;s1 ðSÞ
h i
1=n
VaRa;s1 ðSÞ nFX12 ða ½FX1 ðs1 =nÞn þ1Þ ; s1 nFX11 ða1=n Þ: ð3:13Þ
Example 3.4 In order to appreciate the influence of the dimension n on the upper
bound given in (3.13), consider FX1 Expðk1 Þ; that is, FX1 ðxÞ ¼ 1 ek1 x ; x [ 0
and FX2 * Pareto(a), namely, FX2 ðxÞ ¼ 1 xa ; x [ 1 and a [ 0. Figure 6 provides
the a-curves of this upper bound, with a ¼ 0:95; k ¼ 0:2 and a = 1.5, for n = 2,
n = 3 and n = 4, respectively, and n1 = n2 = n. We remark that increasing the
dimension n increases the proposed upper bound with respect to the order : h
400
n=2
n=3
350
n=4
300
Lower α−curve values
250
200
150
100
50
0
0 10 20 30 40 50 60 70 80 90 100
s1
Fig. 6 Graphical representation of the upper bounds of the lower orthant VaR Graphical representation
of the upper bounds of VaRa;s1 (S) for n = 2, 3, 4
123
342 H. Cossette et al.
4 Applications
In this section, we suggest methods based on the bivariate lower and upper orthant
VaR to obtain optimal capital allocation sets. Two optimization criteria are
developed to select a bivariate set of values from these curves. The objective is to
allocate a value to each homogeneous risk, that could be used for comparison or for
capital requirements of a company with several business lines. These criteria are
developed mainly to fulfil practical needs. The bivariate lower and upper orthant
VaR curves are useful for risk comparison, but in several situations, companies or
regulators need to allocate a single amount to each business line or risk of a
portfolio. Therefore, a set has to be selected from the bivariate VaR. As shown in
Sect. 2.4, we must have a convex lower orthant VaR and a concave upper orthant
VaR, and when this condition is respected, one can obtain a bivariate set of values
from the curves, based on two different approaches. Using the bivariate lower
orthant VaR, the allocation couple has to be such that the probability that X1 is
smaller than x1 and X2 is smaller than x2 equals a: To find an allocation couple from
the curve ðx1 ; VaRa;x1 ðXÞÞ; we propose two different criteria of interest in finance,
actuarial science and quantitative risk management. Analogous results can be
obtained from the curve ðx1 ; VaRa;x1 ðXÞÞ:
123
Bivariate lower and upper orthant value-at-risk 343
stand-alone basis, with the strongest dependence level and the possibility of risk
mitigation. This interpretation allows the user to quantify the impact of protecting
each homogeneous risk, without the possibility of aggregation.
The second approach is the Proportional allocation. The idea of this method is to
preserve the same ratio of the univariate VaR, that is to consider ðx
1 ; VaRa;x
1 ðXÞÞ
solution of
2
VaRa ðX1 Þ
min x1 VaRa;x1 ðXÞ :
x1 [ F11 ðaÞ VaRa ðX2 Þ
Again, if VaRa;x1 ðXÞ is convex, the minimum is obtained by solving the equation
d
VaRa;x1 ðXÞ ¼ VaRa ðX2 Þ=VaRa ðX1 Þ:
dx1
Explicit forms for inverse bivariate cdf’s do not exist for most cases. Copulas are
more tractable for that purpose, as shown in an example in the last section. The
intuitive interpretation of this minimization is to calculate the set that allocates the
same proportion to each risk as if they were comonotonic and could be mitigated.
The latter framework represents the strongest dependence level between risks that
are aggregated, which is often considered for capital requirement purposes. If no
closed-form expression exists, bounds can be found and optimization methods can
be used, as shown in the next example.
Example 4.1 Consider the random couple (X1, X2), following a bivariate mixture
of Erlang distributions with the same scale parameter h. The joint pdf is
1 X
X 1 Y
2
fX1 ;X2 ðx1 ; x2 j sm ; hÞ ¼ sm1 ;m2 hðxj ; mj ; hÞ;
m1 ¼1 m2 ¼1 j¼1
with
s1;1 s1;2 s1;3 0:2 0:1 0
sm ¼ ¼ ;
s2;1 s2;2 s2;3 0:4 0 0:3
and sm1 m2 = 0 for m1 = 3, 4, … and m2 = 4, 5, …. Also, hð; a; bÞ represents the
pdf of a gamma distribution with shape and scale parameters a and b respectively.
We obtain the following results for the allocation couples resulting from the two
allocation criteria previously presented.
Since VaRa(X1) [ VaRa(X2), the allocation to X1 is always higher in the
Proportional allocation couples. The Orthogonal projection allocation provides the
closest couple from (VaRa(X1), VaRa(X2)), resulting in a smaller total than with the
Proportional allocation, but not preserving the proportion of each risk on the
aggregate risks. In Table 1, we see that the sum of the components of the orthogonal
123
344 H. Cossette et al.
Table 1 Couples resulting from the Orthogonal projection and Proportional allocation criteria
a Orthogonal projection Total Proportional Total VaRa (X1 ? X2)
projection and proportional allocation couples are higher than the VaR of the sum of
the components. This is because each component is always protected to the level
a, without considering the value of the remaining rv. h
Note that x
1 þ VaRa;x
1 ðXÞ VaRa ðX1 Þ þ VaRa ðX2 Þ and x
1 þ VaRa;x
1 ðXÞ
VaRa ðX1 Þ þ VaRa ðX2 Þ: This is because the protection level a is dedicated to both
risk, without embedding any possibility of risk mitigation. The minimal value of
x
1 þ VaRa;x
1 ðXÞ and x
1 þ VaRa;x
1 ðXÞ are obtained in the situation where X1 and X2
are comonotonic. Then, as the dependence gets less positive between the rv’s, the
bivariate lower orthant curve would be higher than in the comonotic scenario, and it
means that if X1 takes a smaller value, X2 should take higher values with a higher
probability, and a higher amount would be necessary to cover both risks at the same
level a.
4.2 Bivariate value-at-risk and Ruin probabilites for a portfolio of bivariate risks
We consider a portfolio with two lines of business. The aggregate claim amounts for
the next period (e.g. a month, three months or a year) for the line i is defined by the
rv Si and the corresponding premium income is denoted by pi, i = 1, 2. We assume
that pi ¼ ð1 þ gi ÞE½Si ; i ¼ 1; 2: The initial reserve allocated to the line i is denoted
by ui, i = 1, 2. Inspired from Chan et al. [4] and Cai and Li [2, 3], we define the
two following ruin probabilities of the next periods
!
[2
wor ðu1 ; u2 Þ ¼ Pr f S i pi [ u i g
i¼1
and
!
\
2
wand ðu1 ; u2 Þ ¼ Pr f S i pi [ u i g :
i¼1
We can relate wor ðu1 ; u2 Þ and wand ðu1 ; u2 Þ to VaRa ðSÞ and VaRa ðSÞ; where
S ¼ðS1 ; S2 Þ: We fix a given value a 2 ð0; 1Þ and assume that the premium rates p1
and p2 are fixed such that pi \VaRa ðSi Þ; i ¼ 1; 2: Using the representations
in (2.1)
ðor Þ ðor Þ
and (2.3) we can express for the given value a, the set of couples u1 ; u2 such
that wor ðu1 ; u2 Þ ¼ 1 a coincides with the curve of VaRa ðS1 p1 ; S2 p2 Þ: It
means that either S1 or S2 stay smaller than their respective (1 - a)% largest value,
without considering the other rv’s value, but consideringthat its valuemight affect
ðandÞ ðand Þ
the rv of interest. Similarly, the set of couples u1 ; u2 such that
123
Bivariate lower and upper orthant value-at-risk 345
wand ðu1 ; u2 Þ ¼ a coincides with the curve of VaRa ðS1 p1 ; S2 p2 Þ: This means
that both S1 and S2 do not exceed the level a. For example, at a level of 99 %, if S1
reaches its 99 % greatest value but S2 is smaller than its 99 % greatest value, wor is
respected, but not wand. Since there are more scenarios
where
either S1 or S2 can
ðor Þ ðor Þ
reach their level a, using wand, the set of couples u1 ; u2 will always provide
ðandÞ ðand Þ
higher values than u1 ; u2 ; as mentioned in Remark 2.3.
In Sect. 2.5, we have demonstrated the impact of the dependence and the
marginal cdf’s on the bivariate VaR’s.
This is therefore
also true for the values
ðor Þ ðor Þ ðand Þ ðandÞ
within the sets of u1 ; u2 and u1 ; u2 :
We illustrate this situation in the following example, using a bivariate compound
Poisson model.
We assume ðS1 ; S2 Þ to be a vector of rv’s following a bivariate compound
distribution where
(P
Mi
ji ¼0 Bi;ji ; Mi [ 0
Si ¼ ; ð4:3Þ
0; Mi ¼ 0
123
346 H. Cossette et al.
Using the previous model, we illustrate the bivariate VaR’s in a context of ruin
probabilities for a portfolio of bivariate risks.
Example 4.2 Let us fix k1 = 2, k2 = 3, s1 = s2 = 1, b1 = b2 = 0.6, g1 = g2 =
25 %. It implies that p1 ¼ p2 ¼ 1:25 E½Si : We obtain the following values
Tables 2 and 3 both illustrate Lemma 2.17. The allocation values obtained from
the bivariate lower and upper orthant VaR are always smaller for S1 than for S2,
because the marginal cdf of S2 that is always smaller than the marginal cdf of S1.
Note that this is the same result as for the univariate VaR. Also, one sees that
the sum of the components of the allocation couples is always smaller from
the orthogonal projection than for the proportional allocation. Moreover, as the
dependence parameter increases, the bivariate lower orthant VaR decreases and the
bivariate upper orthant increases (Tables 2, 3).
ðorÞ ðorÞ
Table 2 Couples u1 ; u2 resulting from the Orthogonal projection and Proportional allocation
criteria for wor ðu1 ; u2 Þ ¼ 1 %:
c Orthogonal Total Proportional Total
projection
ðandÞ ðandÞ
Table 3 Couples u1 ; u2 resulting from the Orthogonal projection and Proportional allocation
criteria for wand ðu1 ; u2 Þ ¼ 1 %:
c Orthogonal Total Proportional Total
projection
123
Bivariate lower and upper orthant value-at-risk 347
Table 2 having higher values than Table 3 show that to make sure that both risks
do not exceed their 99 % respective worst possible values, without restriction on the
values of the remaining risk, more has to be kept aside than to make sure that the
worst 1 % is not reached by any of the two risks. h
Now, we consider an insurance company with two lines of business (i = 1, 2). The
two vectors of rv’s (risks) associated to the lines 1 and 2 are
0 1 0 1
X1;1 X2;1
BX C BX C
B 1;2 C B 2;2 C
X1 ¼ B C and X2 ¼ B C;
@ ... A @ ... A
X1;n X2;n
Line1 Line2
It implies that
123
348 H. Cossette et al.
Xm X
m
ðhÞ
FX1;j ;X2;j jH¼h x1;j ; x2;j ¼ p1;2 ðl1 ; l2 ÞH x1;j ; l1 ; b1 H x2;j ; l2 ; b2 ;
l1 ¼1 l2 ¼1
m X
X m
l1
l2
ðhÞ b1 b2
MX1;j ;X2;j jH¼h t1;j ; x2;j ¼ p1;2 ðl1 ; l2 Þ :
l1 ¼1 l2 ¼1
b1 t1;j b2 t2;j
Let
ðhÞ
X
m
ðhÞ
p1 ð l 1 Þ ¼ p1;2 ðl1 ; l2 Þ;
l2 ¼1
and
ðhÞ
X
m
ðhÞ
p2 ð l 2 Þ ¼ p1;2 ðl1 ; l2 Þ:
l1 ¼1
Also, we have
!
X
m
ðhÞ
Y
n
FXi;1 ;...;Xi;n jH¼h xi;1 ; . . .; xi;n ¼ pi ðli Þ H xi;j ; li ; bi ;
li ¼1 j¼1
X
m n
Y li !
ðhÞ bi
MXi;1 ;...;Xi;n jH¼h ti;1 ; . . .; ti;n ¼ pi ð l i Þ :
li ¼1 j¼1
bi ti;j
We obtain
Z X
m X
m
ðhÞ
FX1;j ;X2;j x1;j ; x2;j ¼ p1;2 ðl1 ; l2 ÞH x1;j ; l1 ; b1 H x2;j ; l2 ; b2 dFH ðhÞ;
l1 ¼1 l2 ¼1
h2AH
Z X
m X
m
l1
l2
ðhÞ b1 b2
MX1;j ;X2;j t1;j ; x2;j ¼ p1;2 ðl1 ; l2 Þ dFH ðhÞ;
l1 ¼1 l2 ¼1
b1 t1;j b2 t2;j
h2AH
Z !
X
m
ðhÞ
Y
n
FXi;1 ;...;Xi;n xi;1 ; . . .; xi;n ¼ pi ð l i Þ H xi;j ; li ; bi dFH ðhÞ;
li ¼1 j¼1
h2AH
Z X
m n
Y li !
ðhÞ bi
MXi;1 ;...;Xi;n ti;1 ; . . .; ti;n ¼ pi ð l i Þ dFH ðhÞ
li ¼1 j¼1
bi ti;j
h2AH
and
123
Bivariate lower and upper orthant value-at-risk 349
FX1;1 ;...;X1;n ;X2;1 ;...;X2;n x1;1 ; . . .; x1;n ; x2;1 ; . . .; x2;n
Z X !
m X m Y n
ðhÞ
¼ p1;2 ðl1 ; l2 Þ H x1;j ; l1 ; b1 H x2;j ; l2 ; b2 dFH ðhÞ;
l1 ¼1 l2 ¼1 j¼1
h2AH
MX1;1 ;...;X1;n ;X2;1 ;...;X2;n t1;1 ; . . .; t1;n ; t2;1 ; . . .; t2;n
Z X m X m Y n
l1
l2 !
ðhÞ b1 b2
¼ p1;2 ðl1 ; l2 Þ dFH ðhÞ:
l ¼1 l ¼1 j¼1
b1 t1;j b2 t2;j
1 2
h2AH
which implies
m X
X m
ðhÞ
FS1 ;S2 jH¼h ðs1 ; s2 Þ ¼ p1;2 ðl1 ; l2 ÞH ðs1 ; n l1 ; b1 ÞH ðs2 ; n l2 ; b2 Þ:
l1 ¼1 l2 ¼1
Also, we have
Z X
m X
m
ðhÞ
FS1 ;S2 ðs1 ; s2 Þ ¼ p1;2 ðl1 ; l2 ÞH ðs1 ; n l1 ; b1 ÞH ðs2 ; n l2 ; b2 ÞdFH ðhÞ
l1 ¼1 l2 ¼1
h2AH
0 1
m X
X m Z
B ðhÞ C
¼ H ðs1 ; n l1 ; b1 ÞH ðs2 ; n l2 ; b2 Þ@ p1;2 ðl1 ; l2 ÞdFH ðhÞA
l1 ¼1 l2 ¼1
h2AH
X
m X
m
¼ p1;2 ðl1 ; l2 ÞH ðs1 ; n l1 ; b1 ÞH ðs2 ; n l2 ; b2 Þ;
l1 ¼1 l2 ¼1
where
Z
ðhÞ
p1;2 ðl1 ; l2 Þ ¼ p1;2 ðl1 ; l2 ÞdFH ðhÞ:
h2AH
We consider the following example, to illustrate the allocation values for two
dependent lines of business, based on the bivariate VaR. The dependence model is
represented by a bivariate mixture of Erlang distributions, as presented above.
123
350 H. Cossette et al.
8 VaRα(X1)→
15
X 2,i
X 2,i
14 6
13
4
12 →VaRα(X1)
2
VaRα(X2)
11 ↓
0
5.5 6 6.5 7 7.5 8 8.5 9 0 1 2 3 4 5 6
X1,i X1,i
Fig. 7 Graphical representation of the bivariate lower and upper orthant VaR with a = 99 %, with
different dependence levels, for single bivariate risks
123
Bivariate lower and upper orthant value-at-risk 351
Table 4 Optimal couples based on the bivariate lower orthant VaR for individual risks (Xi,1, Xi,2)
a c Orthogonal Total Proportional Total
Table 5 Optimal couples based on the bivariate upper orthant VaR for individual risks (Xi,1, Xi,2)
a c Orthogonal Total Proportional Total
upper orthant VaR are more varying in terms of s, which means that the probability
of exceeding a specified level for both rv’s is more affected by the dependence
structure.
Figure 8 illustrates the bivariate lower and upper orthant curves for the set
(S1, S2). We have the same small difference between the lower orthant VaR curves.
We can draw the same conclusions as for the individual bivariate risks.
Tables 6 and 7 show that the same relation is obtained as for Tables 4 and 5. We
also see that the amounts are higher for each aggregate line of business. Again, the
total allocation for both lines is always smaller using the orthogonal projection
method than the proportional allocation method. h
60
74 τ=0 τ=0
τ=0.5 55 τ=0.5
↑
72 τ=1 VaRα(X2) τ=1
50
70
45 VaRα(X1)→
68
40
66
S2
S2
35
64
30
62
25
60
→VaRα(S1) 20
58
VaRα(S2) 15
56 ↓
10
28 29 30 31 32 33 34 35 36 37 38 10 12 14 16 18 20 22 24 26 28 30
S1 S1
Fig. 8 Graphical representation of the bivariate lower and upper orthant VaR with a = 99 %, with
different dependence levels for the business lines
123
352 H. Cossette et al.
Table 6 Optimal couples based on the bivariate upper orthant VaR for lines of business (S1, S2), with
n = 10
a c Orthogonal Total Proportional Total
Table 7 Optimal couples based on the bivariate upper orthant VaR for lines of business (S1, S2), with
n = 10
a c Orthogonal Total Proportional Total
This subsection intends to illustrate the use of bivariate set-valued quantiles and
motivate our results on confidence regions, optimal couples and bounds. Describing
relationships among different dimensions of an outcome is a basic actuarial
technique for explaining the behavior of financial security systems to concerned
businesses and policy makers. A VaR trade-off between two stock indices have been
studied by Cherubini and Luciano [5] and Cherubini et al. [6]. Studying the
bivariate VaR is useful in the decision process, based on a predefine a-level. It
shows the possible vectors that can be obtained if each risk reaches the a-level,
considering the dependence between them. At level a, the VaR movement between
two stock indices can be studied to understand and quantify the impact of
transfering a stock from one class to another.
Example 4.4 Consider a random vector X with joint cdf F/ 2 CðFX1 ; FX2 Þ such
that
F/ ðx1 ; x2 Þ ¼ C/ FX1 ðx1 Þ; FX2 ðx2 Þ ; ð4:5Þ
where C/ is the archimedean copula with generator / defined as
C/ u1 ; u2 ¼ /1 /ðu1 Þ þ /ðu2 Þ ; ð4:6Þ
123
Bivariate lower and upper orthant value-at-risk 353
Table 8 Couples resulting from the Orthogonal projection and Proportional allocation criteria
a Orthogonal projection Total Proportional Total
123
354 H. Cossette et al.
us to compute the confidence region at level a. The values in Table 9 represent the
level curves covering a % of the area under VaRa ðXÞ:
Figure 9 shows the confidence curves for a = 0.95. This curve coincides with
VaR0:8114 ðXÞ:
Note that VaR:8114 ðXÞ can be viewed as a threshold curve such that the
probability that the components of the loss X over the given time horizon are
simultaneously under this curve with probability 0.95. h
Example 4.5 Consider a portfolio of 10 risks of a third party liability in motor
insurance, where the risks Xi (i = 1, …, 10) have to be split into a physical
P damage
claim PXi,1 and a material damage claim Xi,2. Let us define S1 = 10 i=1Xi,1 and
S2 = 10 X
i=1 i,2 , the rv’s representing the total amount for each type of claim. The
random vector (S1, S2) is studied in order to establish the capital allocated to each
party, knowing that Xi,j, i = 1, …, 10 and j = 1,2 are covered by different parties.
Suppose that each physical damage rv Xi,1 follows an exponential distribution
(k = 1.5) and each material damage rv Xi,2 follows a Pareto distribution (aP = 2).
Also, Xi,1, i = 1, …, 10 and j = 1,2 are independent within each class and the
dependence between S1 and S2 is unknown. The capital allocation for each party
based on the optimal couple criterion provided in the previous section is a set
(S1, S2) from the lower orthant VaR.
The distance between each a-level curve is large, showing the effect of heavy-
tails. Also, Fig. 10 illustrates that the bivariate risk measure increases with a, with
respect to the order ; similarly to Fig. 6. It is interesting to note the impact of the
30
VaR.95(X1,X2)
28
VaR.8114(X1,X2)
26
24
22
20
18
16
14
12
10
10 15 20 25 30 35
Fig. 9 Graphical representation of the lower orthant confidence region VaR:8114 (X) coinciding for
VaR:95 (X)
123
Bivariate lower and upper orthant value-at-risk 355
800
α=.95
α=.99
700
Lower α−curve values α=.995
600
500
400
300
200
100
40 50 60 70 80 90 100 110 120 130
s1
Fig. 10 Graphical representation of the upper bounds of the lower orthant VaR VaRa;s1 (S)
123
356 H. Cossette et al.
to establish the upper bound, using the bivariate lower orthant VaR, considering the
dependence model of S1 and S2 (Table 10). h
Acknowledgments The authors wish to thank the anonymous reviewers for their detailed and helpful
comments. This work was partially supported by the Natural Sciences and Engineering Research Council
of Canada, the Fonds qubcois de la recherche sur la nature et les technologies, the Chaire en actuariat de
l’Université Laval, and the Faculty of Arts and Science of Concordia University.
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123
Bivariate lower and upper orthant value-at-risk 357
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