Operational Risk Modeling in Financial Services

CHAPTER 14The XOI Methodology

The XOI, or Exposure, Occurrence, and Impact method, is a generalisation of the approach described in the Chapter 13's example of car fleet management.

14.1 STRUCTURE DESIGN

14.1.1 Choice of the Exposed Object

Two essential conditions must be met to ensure that the calculations obtained from the model are valid:

1. Exposure units must be exposed independently to the risk.
2. Each exposure unit should only be hit once in the year.

These conditions have an impact on the choice of the exposure definition:

• The fact that an exposed unit is hit by the risk should not increase the probability of another also being hit.
• If a unit can be struck several times in the year, it must be broken down into several units with a shorter time interval.

In most cases, perfect independence is impossible, for at least one reason: the occurrence of an event with a severe impact in a firm will trigger immediate corrective actions, which should reduce the occurrence probability of other similar type events, at least in the short term.

Even if it is clear that no exposure measure choice can guarantee perfect independence, it is important to ensure that an obvious dependence does not exist.

A scenario describes the occurrence of a conjunction of events that leads to a loss. But what is the risk exposed object precisely? For example, let us consider an internal fraud on transfers. An employee issues and processes fraudulent transfers. What is the exposed object? The transfer? ...