Estimation of Operational Risk Capital Charge under Parameter Uncertainty

Details Estimation of Operational Risk Capital Charge under Parameter Uncertainty Estimation of Operational Risk Capital Charge under Parameter Uncertainty

2009-04-11

arxiv.org/abs/0904.1771v1

The Journal of Operational Risk 3(1), pp. 51-63, 2008 www.journalofoperationalrisk.com

Economy

Quantitative Finance

Risk Management

Scientific paper

Many banks adopt the Loss Distribution Approach to quantify the operational risk capital charge under Basel II requirements. It is common practice to estimate the capital charge using the 0.999 quantile of the annual loss distribution, calculated using point estimators of the frequency and severity distribution parameters. The uncertainty of the parameter estimates is typically ignored. One of the unpleasant consequences for the banks accounting for parameter uncertainty is an increase in the capital requirement. This paper demonstrates how the parameter uncertainty can be taken into account using a Bayesian framework that also allows for incorporation of expert opinions and external data into the estimation procedure.

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