A Note on Parameter Risk

Consideration of parameter risk is particularly important for actuarial models of uncertainty. That is because—unlike process risk—parameter risk does not diversify when modeling a large volume of independent exposures. Without consideration of parameter risk, decision makers may be tempted to underwrite higher volumes as a result of the apparent high degree of predictability in the mean outcome. However, the financial impact of parameter error is magnified by volume and doing so could have significant consequences for the firm. In this paper, we present an inventory of uncertainty models associated with various approaches that actuaries use in estimating model parameters.