Loss Frequency and Loss Severity
- Loss frequency is defined as number of losses over a specific period of time
- Loss frequency is often modeled with Poisson distribution
- In Poisson distribution, mean and standard deviation is equal to the single parameter, lambda.
- Loss severity is defined as the value of financial loss suffered
- Loss severity is modeled using lognormal distribution
- Loss frequency and loss distribution are combined to simulate the expected loss distribution.
- This is known as convolution
- Monte Carlo Simulation process is used to run this simulation