Operational Risk Capital Models (2nd edition)
First published:
ISBN: 9781782724223
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Hybrid model construction: Integration of ILD, ED and SA
Rafael Cavestany, Daniel Rodríguez Perez and Fabrizio Ruggeri
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
Once the modelling of the four data elements has been performed, as presented in the last three chapters, we now look into the merger of these data elements. The merger will result in a single loss severity distribution (or loss frequency distribution if applied to frequencies) of the operational losses for the operational risk category (ORC) incorporating different data elements.
Regarding the merger of different data elements, the Basel Committee on Banking Supervision “Operational Risk – Supervisory Guidelines for Advanced Measurement Approaches” (BCSG-AMA) states: “A bank should carefully consider how the data elements are combined and used to ensure that the bank’s operational risk capital charge is commensurate with its level of risk exposure”.
This chapter presents credibility theory and various methods for merging the different data elements into a single loss or frequency distribution, organised in the following sections.
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“Credibility theory: Determining the weights for internal loss data (ILD), external loss data (ED) and scenario analysis (SA) in the hybrid model”: In this section, we look at the different models for credibility theory that permit us
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