Analysis of an aggregate loss model in a Markov renewal regime

Abstract In this article we consider an aggregate loss model with dependent losses. The loss occurrence process is governed by a two-state Markovian arrival process ( M A P 2 ), a Markov renewal process that allows for (1) correlated inter-loss times, (2) non-exponentially distributed inter-loss times and, (3) overdisperse loss counts. Some quantities of interest to measure persistence in the loss occurrence process are obtained. Given a real OpRisk database, the aggregate loss model is estimated by fitting separately the inter-loss times and severities. The M A P 2 is estimated via direct maximization of the likelihood function, and severities are modeled by the heavy-tailed, double-Pareto Lognormal distribution. In comparison with the fit provided by the Poisson process, the results point out that taking into account the dependence and overdispersion in the inter-loss times distribution leads to higher capital charges.