Derivation of the joint distribution and capitalisation of operational risk

Rafael Cavestany and Daniel Rodríguez Perez

Having described in Chapter 9 the methods for creating severity and frequency distribution hybrid models with different data elements, we now look at the derivation of the joint distribution and capitalisation of operational risk using hybrid or single-data-element models.

The process described in Chapter 9 delivers a single severity or frequency distributions per operational risk category (ORC), incorporating all the operational loss information contained in internal loss data (ILD), external loss data (ED) and scenario analysis (SA). This input is then used for the determination of the joint distribution and capitalisation of operational risk. Basel Committee on Banking Supervision “Operational Risk – Supervisory Guidelines for Advanced Measurement Approaches” (BCSG-AMA) states: “The techniques to determine the aggregated loss distributions should ensure adequate levels of precision and stability of the risk measures”, also suggesting: “As such, simulation, numerical or approximation methods are necessary to derive aggregated curves (eg, Monte Carlo simulations, Fourier Transform-related methods, Panjer algorithm and Single Loss Approximations)”.

The final output of this

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