Journal of Operational Risk

Marcelo Cruz

Lehman Brothers

Welcome to the third issue of the second volume of The Journal of Operational Risk. The financial industry is currently starting to recover from the now infamous “subprime mortgage crisis” that brought volatility to a level rarely seen in the market. During this period we also saw trading volumes soar to record levels in all financial firms and many of them also reported higher levels of losses due to transaction processing errors, which are somehow suddenly expected after firms are subjected to larger volumes than they are prepared to cope with. In addition, the credit weakness that made several hedge funds and smaller participants in the financial market either close or limit fund withdraws, also brought the concern of exposures to these agents as the industry also had to deal with severe delays in getting ISDA master agreements signed on time – a situation greatly improved compared with a year ago but still not resolved.

This summer showed us that market, credit and operational risk can move in the same direction when hit by a crisis. This crisis will likely be reflected in forthcoming articles.

For those of you who have just got hold of this Journal for the first time, the main objective of The Journal of Operational Risk is to publish high-quality research on the risk measurement and management of operational risk and to promote greater understanding of this new and fast-growing area of risk. This Journal also aims to be a forum for discussions on this subject, facilitating the publication of not only top-quality operational risk technical papers but also papers that discuss hot topics in the industry. Research in operational risk is a field that is growing at a fast pace in both the financial industry and academia. There are currently many lines of research, most of them trying to overcome the challenges presented by the new regulatory standards created by the Basel II Accord. However, currently there is no single forum for the debate of these ideas. The Journal of Operational Risk comes to fulfill this much needed role. Please see the website www.journalofoperationalrisk.com for more details.

The Journal of Operational Risk is the vehicle for communicating results in the modeling and management of operational risk. Examples of some areas of interest are: statistical/actuarial methods and estimation issues, causal models, extreme value theory, scenario-analysis-based models, Bayesian methods, uses of external data within the framework, etc. We also encourage the submission of papers on new ideas and research on subjects such as corporate governance, business continuity plans, enterprise-wide risk, financial crime and the development of controls to avoid them, insurance, etc.

At this moment I would like to invite you to really appreciate the high quality of articles in this edition of The Journal of Operational Risk.We thank the authors for their trust in this growing publication and appreciate all the encouragingmessages sent by a number of colleagues in the industry and academia. All of this gives us www.journalofoperationalrisk.com viii Letter from the Editor-in-Chief comfort that we are taking the right steps to build this new global industry forum for operational risk.

Research Papers

In this issue, there are two excellent research papers in the main section. In the first paper, "The quantification of operational risk using internal data, relevant external data and expert opinion", Lambrigger et al tackle one of the more challenging aspects of operational risk quantification, which is the aggregation of the different types of data. They do that by developing a Bayesian inference method that considers three types of data in the parameter estimation. This is a high-quality paper that I strongly advise readers to take a look at.

In the second paper, "Simulation of the annual loss distribution in operational risk via Panjer recursions and Volterra integral equations for value-at-risk and expected shortfall estimation", Peters et al have developed an enhancement to the usual Monte Carlo simulation method to aggregate frequency and severity distributions by estimating operational VaR for a firm using importance sampling, Markov Chain Monte Carlo algorithms. They apply Volterra integral equations of the second kind to reformulate the problem of evaluation of the density of the random sum.

Operational Risk Forum

This section is intended to provide a less formal forum on findings and ideas about operational risk without the academic rigor demanded in the main section. The mission of the Forum is to promote active discussions of current issues in operational risk. The main goal of the submitted articles is to bring a higher level of understanding to both industry and academia on issues and topics that might not normally be readily and easily accessible to either side.

In this current issue, Andrey Y. Rogachev shows a real case of the implementation of an enterprise risk management project in "Enterprise risk management and its practical implementation". Also Mohammad I. Fheili writes for the second time in this section giving his views on employee turnover in the article "Employee turnover: an HR risk with firm-specific context".

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