On Bayesian approach to composite Pareto models.

Abstract

In data modelling using the composite Pareto distribution, any observations above a particular threshold value are assumed to follow Pareto type distribution, whereas the rest of the observations are assumed to follow a different distribution. This paper proposes on the use of Bayesian approach to the composite Pareto models involving specification of the prior distribution on the proportion of data coming from the Pareto distribution, instead of assuming the prior distribution on the threshold, as often done in the literature. Based on a simulation study, it is found that the parameter estimates determined when using uniform prior on the proportion is less biased as compared to the point estimates determined when using uniform prior on the threshold. Applications on income data and finance are included for illustrative examples.