Operational Risk Capital Models (2nd edition)
First published:
ISBN: 9781782724223
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Loss data modelling: ILD and ED
Rafael Cavestany and Daniel Rodríguez Perez
Loss data modelling: ILD and ED
Introduction
Challenges of operational risk advanced capital models
Part I: Capture and Determination of the Four Data Elements
Collection of operational loss data: ILD and ED
Scenario analysis framework and BEICFs integration
Part II: General Framework for Operational Risk Capital Modelling
Loss data modelling: ILD and ED
Distributions for modelling operational risk capital
Scenario analysis modelling
Exposure-based approaches
BEICFs modelling and integration into the capital model
Hybrid model construction: Integration of ILD, ED and SA
Derivation of the joint distribution and capitalisation of operational risk
Backtesting, stress testing and sensitivity analysis
Regulatory approval report
Evolving from a plain vanilla to a state-of-the-art model
Part III: Use Test, Integrating Capital Results into the Institution’s Day-to-day Risk Management
Strategic and operational business planning and monitoring
Risk/reward evaluation of mitigation and control effectiveness
Appendix 1: Credibility theory
Appendix 2: Mathematical optimisation methods required for operational risk modelling and other risk mitigation processes
Business risk quantification
In this chapter we examine the modelling of operational loss data, which can be applied in the modelling of internal loss data (ILD) and external loss date (ED). The use of ILD in the capital model permits us to incorporate relevant information on the specific characteristics of the risk profile of an institution, as reflected in its loss experience dominated by high-frequency events. The use of ED permits us to complement the modelling with the experience of peer institutions, which is not reflected in the ILD, accompanying ILD with low-frequency/high-severity events.
ILD is generally modelled by determining the frequency and severity distribution of the loss data used for each operational risk category (ORC). The importance of using ILD in capital modelling is recognised by the Basel Committee on Banking Supervision (BCBS) in its 2011 document “Operational Risk – Supervisory Guidelines for Advanced Measurement Approaches” (BCSG-AMA): “Supervisors expect ILD to be used in the operational risk measurement system (ORMS) to assist in the estimation of loss frequencies; to inform the severity distribution(s) to the extent possible”. In addition, the BCSG-AMA states, “Supervisors
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