Journal of Operational Risk

Marcelo Cruz

Welcome to the fall 2011 issue of The Journal of Operational Risk. Once again, the financial industry is experiencing a crisis of confidence. During the summer, we saw quite a few systemic crashes that were reflected in severe drops in stock exchange indices, jumps in treasury prices, flights to quality, etc. These dramatic price movements could all be explained by the Greek economic situation, the US downgrade by Standard&Poor's or by speculation over the economic situation of European countries and banks. It seems that we are one bad weekend away from the 2008 crisis occurring all over again. Many analysts believe that this is a continuation of unresolved issues from 2008.

The truth is that the real economy has not recovered completely since then. We had a rebound in 2009, but it seems that this was fueled by cheap money generated by low interest rates rather than being based on economic facts. This economic climate poses an extreme risk for firms, and risk managers are again required to give maximum attention to exposures. It is interesting to see the increased attention being paid to operational risk. Many banks face severe operational risk exposures from pending litigation from the 2008 crisis, and these exposures have started to concern the public even more than some banks’ share prices.

In terms of operational risk, it is interesting to observe the divide between US and European banks with regard to measurement. In Europe, banks and regulators seem to have a greater acceptance of qualitative techniques for scenario analysis, and quite a few large banks make these qualitative techniques the centerpiece of their operational risk models. In the US it is the other way around: banks’ operational risk capital models are driven much more by data and quantitative techniques. Data, therefore, plays a much bigger role in the US than it does in Europe. It would be easy to say that this divide is driven by regulatory pressure, but this is not the whole truth. We have heard reports from many US banks that businesses actually rejected the use of such qualitative techniques as inputs to their capital models. It would be interesting to see papers noting these differences (or questioning them).

As the journal has reached a certain level of maturity after its five years in existence, the board, the publishers and I are now reflecting on how the journal can be improved in terms of scope and breadth of research. We are considering a number of exciting alternatives and we hope to make some decisions soon.We hope to have some news for our readers and subscribers in the next issue.

Regarding the state of operational risk research, I ask potential authors to continue to submit to the journal. Again, I would like to emphasize that the journal is not solely for academic authors.We at The Journal of Operational Risk would be happy to see more submissions containing practical, current views on relevant matters as well as papers focusing on the technical aspect of operational risk.

RESEARCH PAPERS

In this issue we bring you two research papers. Both touch on very popular current issues in the industry. In the first paper, “Determining the total loss distribution from the moments of the exponential of the compound loss”, Henryk Gzyl tackles the problem of determining the distribution function when a compound loss is used for total loss. He explores methods of reconstructing the cumulative distribution function based on knowledge of the Laplace transform of the compound loss and, more specifically, based on knowledge of the moments of the probability density of the exponential of compound loss.

In the second technical paper, “A copula-based simulation model for supply portfolio risk”, Halis Sak and Çagrõ Haksöz continue their series of interesting papers on the operational risk effects on supply chains. This time they introduce a copula-based model in the presence of dependent breaches of contracts. They demonstrate their method using a supply-chain contract portfolio of commodity metals traded at the London Metal Exchange.

FORUM PAPERS

We have two forum papers in this issue that serve to balance the very technical papers in the previous section. In the first paper, “A framework for the analysis of reputational risk”, our board member Sergio Scandizzo (it should be noted here that all papers, including those from our board members, are submitted for peer review) presents an analytical framework for reputational risk. This is an incredibly popular subject nowadays, particularly with the financial crisis and the uncertainties that this environment brings. Most firms are trying to find improved ways to manage their reputations in the eyes of their investors and clients.

In the second paper, “The role of systemic people risk in the global financial crisis”, Patrick McConnell andKeith Blacker provide an interesting viewof the role of people risk in the global financial crisis of 2008. I hope you enjoy these excellent papers and find them useful.