Operational Risk Modelling and Management

Taking into account the standards of the Basel Accord, Operational Risk Modelling and Management presents a simulation model for generating the loss distribution of operational risk. It also examines a multitude of management issues that must be considered when adjusting the quantitative results of a comprehensive model.The book emphasizes techniques that can be understood and applied by practitioners. In the quantitative portions of the text, the author supplies key concepts and definitions without stating theorems or delving into mathematical proofs. He also offers references for readers looking for further background information. In addition, the book includes a Monte Carlo simulation of risk capital in the form of a run-through example of risk calculations based on data from a quantitative impact study. Since the computations are too complicated for a scripting language, a prototypical software program can be downloaded from www.garrulus.comHelping you navigate the tricky world of risk calculation and management, this book presents two main building blocks for determining how much capital needs to be reserved for operational risk. It employs the loss distribution approach as a model for calculating the risk capital figure and explains risk mitigation through management and management's actuations.

List of Figures	p. xv
List of Tables	p. xix
Preface	p. xxi
About the Author	p. xxiii
Introduction to Operational Risk	p. 1
Why Regulate Banks?	p. 1
Additional Supervision	p. 4
The Basel Regulatory Effort	p. 10
Risk and Capita	p. 13
How Do We Define Risk?	p. 13
What Is Risk Management?	p. 16
Capital	p. 17
Liquidity	p. 22
Ruin Theory	p. 24
Risk and Aversion	p. 26
What Is Operational Risk?	p. 28
Economic Capital for Operational Risk	p. 34
Operational Risk under Basel 2	p. 36
Basic Indicator Approach	p. 36
Standardised Approach	p. 37
Advanced Measurement Approach	p. 39
Role of Insurance	p. 40
Regulation after the Crisis	p. 44
The Problem Context	p. 49
General Remarks	p. 49
The Data Problem	p. 50
Scaling	p. 51
Mixing	p. 51
Paucity	p. 51
External Loss Data	p. 53
The Dependency Problem	p. 53
The Insurance Problem	p. 54
The Mapping Problem	p. 54
The Management Problem	p. 58
Strategic Risks of a Bank	p. 58
AMA Standards	p. 59
The Knowledge Problem	p. 61
Probability, Causality and Other Primitives	p. 61
Probability	p. 62
Classical Probability	p. 62
Logical Probability	p. 63
Frequency Interpretations	p. 64
Propensity Interpretations	p. 65
Subjective Probability	p. 65
Causality and Correlation	p. 67
Elicitation and Expert Knowledge	p. 74
Individual Bias	p. 74
Group Bias	p. 78
Elicitation Theory	p. 80
Risk Perception and Risk Judgements	p. 82
The Modelling Approach	p. 85
Simulation and the Monte Carlo Method	p. 85
General Concepts	p. 85
Monte Carlo Simulation	p. 86
Loss Distribution Approach and Simulation	p. 90
General Model Structure	p. 91
Modelling Losses	p. 92
Data Requirements	p. 94
External Data Usage	p. 95
Data Modelling and Distributions	p. 96
Distributions	p. 97
Annual Aggregate Loss Distributions	p. 98
Compound Distributions	p. 102
Frequency Distributions	p. 104
Severity Distributions	p. 107
Creating New Distributions	p. 118
Tails of the Distributions	p. 122
Moments of the Compound Distribution	p. 124
Data Fitting	p. 126
Parameter Estimation	p. 126
Goodness-of-Fit Tests	p. 139
Graphical Analysis	p. 141
Extreme Value Theory	p. 143
Random Number Generators	p. 144
Run-Through Example: Quantitative Impact Study Data	p. 146
Correlation of Losses	p. 152
Motivation	p. 152
Measures of Association	p. 153
Model Choices	p. 158
The Normal Transformation	p. 159
The Correlation Transformed	p. 161
Feasibility	p. 162
Extension beyond Normality	p. 164
Correlation of the Total Losses	p. 167
Estimation of the Correlations	p. 169
Testing for Correlation	p. 171
Parametric Tests	p. 171
Rank-Based Tests	p. 172
Dependencies between Events and Business Lines	p. 175
Sound Correlations?	p. 176
Risk Measures and Allocation	p. 177
Risk Measures	p. 177
Coherent Risk Measures	p. 179
Comparing VaR with Expected Shortfall	p. 181
Allocation	p. 183
Some Properties	p. 184
Allocating Methods	p. 185
Covariance Principle	p. 185
Expected Shortfall	p. 186
Simulating the Risk Measures	p. 188
Insurance Modelling and Mitigation	p. 189
Insurance	p. 189
Insurance Characteristics	p. 190
Insurance Pricing	p. 195
Dedicated Provisions	p. 198
Mapping Events to Insurance Policies	p. 200
Motivation	p. 200
Preliminaries	p. 201
Nominal Categories	p. 202
Quantitative Consideration	p. 203
Estimating a Map	p. 204
Back-Testing	p. 205
Mapping Events to Lines of Business	p. 209
The Simulation Model	p. 209
The Map from Optimisation	p. 210
Calculating the Economic Capital	p. 215
Accuracy of Result	p. 215
The Jackknife Estimator	p. 216
Conditioning the Data	p. 218
Results of the Run-Through Example	p. 219
The Economic Capital	p. 220
Insurance Effect	p. 223
Comparison with the Standardised Approach	p. 225
Summary and Conclusion	p. 226
Managing Operational Risk	p. 227
Management and Organisation	p. 227
Management System	p. 227
Conception of Man	p. 228
Leadership Theory	p. 230
Motivation Theory	p. 232
Management Styles	p. 234
Organisational Structures	p. 236
Agency Theory	p. 246
Environment	p. 247
External Environment	p. 248
Internal Environment	p. 250
Culture	p. 253
America and Europe	p. 255
Gender Differences	p. 256
Legal Systems	p. 257
Crime	p. 261
Communication	p. 264
Innumeracy, or More on Communication	p. 266
Operational Risk Framework	p. 273
Operational Risk Structure	p. 276
Operational Risk Process	p. 281
Risk Objectives	p. 281
Risk Identification	p. 282
Risk Assessment and Measurement	p. 286
Risk Monitoring and Communication	p. 287
Risk Mitigation and Control	p. 291
Business Environment and Internal Control Factors	p. 293
Business Environment	p. 293
Internal Control	p. 294
Factors and Indices	p. 301
Implications for the AMA	p. 308
Scenario Analysis	p. 311
Optimising the Insurance Programme	p. 317
What Is Optimisation?	p. 317
The Variables	p. 318
The Objective Function	p. 319
Cost and Benefit of Risk Mitigation	p. 321
Audit, Reporting and Disclosure of Operational Risk	p. 323
Financial Audit	p. 323
Controls Testing	p. 327
Regulatory Audit	p. 330
Risk Management versus Internal Control	p. 336
Summary and Conclusion	p. 340
Conclusions	p. 343
Appendix	p. 347
Factors Influencing Risk Perception	p. 349
Various Death or Harm Frequencies	p. 350
Basel 2's Loss Event Type Classification	p. 351
Some Regulatory Report Templates	p. 356
Monte Carlo Example	p. 358
Bibliography	p. 361
Index	p. 381
Table of Contents provided by Ingram. All Rights Reserved.

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