Operational Risk Modeling: An Evaluation of Competing Strategies

Being still in its early stages, operational risk modeling has, so far, mainly been concentrated on the marginal distributions of frequencies and severities within the context of the Loss Distribution Approach (LDA). A realistic quantitative model, however, should be capable of modeling the characteristics of the loss distribution while providing stable estimates, incorporating dependencies and overcoming the overly simplistic assumption of a perfect positive correlation among operational losses. The scarcity of available real-world data has prevented the development of best-practice guidelines among practitioners. In this study, drawing on a fairly large real-world data set, we analyze the effects of competing state-of-art strategies in univariate and multivariate modeling for estimating aggregate risk capital.