Correlation and diversification effects in operational risk modelling

Antoine Frachot, Thierry Roncalli and Eric Salomon stress that there are strong arguments in favour of low levels of aggregate losses in operational risk capital calculation under the advanced measurement approach. This is despite the fact that at present Basel II calls for incorporating a high level of correlation between events in computations

The effects of diversification in operational risk modelling are crucial, particularly when capital computations are performed. Though the Basel Committe on Banking Supervisors’ third consultative paper (CP3) is vague about the correlation that should be expected between, say, internal fraud and damage to physical assets, common sense suggests that operational risk events might be, at least