Log-Normal or Over-Dispersed Poisson?

Abstract

Although both over-dispersed Poisson and log-normal chain-ladder models are popular in claim reserving, it is not obvious when to choose which model. Yet, the two models are obviously different. While the over-dispersed Poisson model imposes the variance to mean ratio to be common across the array, the log-normal model assumes the same for the standard deviation to mean ratio. Leveraging this insight, we propose a test that has the power to distinguish between the two models. The theory is asymptotic, but it does not build on a large size of the array and, instead, makes use of information accumulating within the cells. The test has a non-standard asymptotic distribution; however, saddle point approximations are available. We show in a simulation study that these approximations are accurate and that the test performs well in finite samples and has high power.

Keywords

• non-nested testing
• encompassing
• chain-ladder