Chapter 11. Statistical Models of Operational Loss


Chair of Risk Management and Director of Research, ICMA Centre, Business School, The University of Reading

Abstract: Under the Basel II accord there are pillar 1 charges for operational risks. These may be assessed using: the basic indicator approach, where the capital charge is a multiple of gross income; the standardized approach, which is similar to the basic indicator approach except being specific to business line; or the Advanced Measurement Approach (AMA), which is the subject of this chapter. The AMA entails the implementation of a statistical model for operational risk assessment. An actuarial approach is standard, whereby statistical distributions are fit to loss frequency and loss severity, the total loss distribution being the compound of these. The models are implemented using a variety of data, including internal and external losses and subjective estimates or scenarios.

Keywords: Basel II, regulatory capital, economic capital, operational risks, Advanced Measurement Approach (AMA), severity, frequency, statistical models of operational loss, Bayesian estimation, scenario analysis, simulation, aggregation, copula

The purpose of this chapter is to give a theoretical but pedagogical introduction to the advanced statistical models that are currently being developed to estimate operational risks, with many examples to illustrate their applications in the financial industry.


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