Copula based hierarchical risk aggregation - Tree dependent sampling and the space of mild tree dependence

Abstract: The ability to adequately model risks is crucial for insurance companies. The method of "Copula-based hierarchical risk aggregation" by Arbenz et al. offers a flexible way in doing so and has attracted much attention recently. We briefly introduce the aggregation tree model as well as the sampling algorithm proposed by they authors. An important characteristic of the model is that the joint distribution of all risk is not fully specified unless an additional assumption (known as "conditional independence assumption") is added. We show that there is numerical evidence that the sampling algorithm yields an approximation of the distribution uniquely specified by the conditional independence assumption. We propose a modified algorithm and provide a proof that under certain conditions the said distribution is indeed approximated by our algorithm. We further determine the space of feasible distributions for a given aggregation tree model in case we drop the conditional independence assumption. We study the impact of the input parameters and the tree structure, which allows conclusions of the way the aggregation tree should be designed.