Operational Risk toward Basel III: Best Practices and Issues in Modeling, Management, and Regulation

CHAPTER 3

Operational Risk Based on Complementary Loss Evaluations

Andrea Giacomelli and Loriana Pelizzon

 

 

ABSTRACT

In this chapter we develop the complementary loss evaluations (CLE) framework for computing the capital charge of a bank for operational risk where CLE refers to subjective and quantitative statistical/actuarial methods for modeling the loss distribution. In this framework, the capital charge is calculated using a value-at-risk measure. First we introduce the analytical statistical/actuarial method based on the mixed frequency models or compound frequency models as a common framework where both the subjective analysis and the quantitative analysis could be integrated. Then we give a detailed description of the subjective method to evaluate losses. In particular, we show how to compute the aggregate loss distribution by compounding the loss severity distribution and the loss frequency distribution based on the self risk assessment approach. Finally, we propose a Bayesian approach to merge the qualitative and the quantitative loss distributions.

3.1 INTRODUCTION

A great deal of research has been conducted over the past few years to address issues raised by the practical implementation of Basel II Advanced Measurement Approaches (AMA). The recent breakdown of internal controls at the Société Générale has emphasized the need of a sound system for operational risk. So far, three different classes of operational risk models have been proposed by various authors. ...