Correlation and diversification effects in operational risk modelling

The Correlation Problem Technical Focus

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 partially, decorrelated. Indeed, that all severe operational risk losses systematically occur simultan