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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

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