A PIECEWISE-DEFINED SEVERITY DISTRIBUTION-BASED LOSS DISTRIBUTION APPROACH TO ESTIMATE OPERATIONAL RISK: EVIDENCE FROM CHINESE NATIONAL COMMERCIAL BANKS

Jianping Li, Jichuang Feng () and Jianming Chen ()
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Jichuang Feng: School of Management, University of Science and Technology of China, Hefei, Anhui 230026, P. R. China
Jianming Chen: Institute of Policy & Management, Chinese Academy of Sciences, Beijing 100190, P. R. China

International Journal of Information Technology & Decision Making (IJITDM), 2009, vol. 08, issue 04, 727-747

Abstract: Following the Basel II Accord, with the increased focus on operational risk as an aspect distinct from credit and market risk, quantification of operational risk has been a major challenge for banks. This paper analyzes implications of the advanced measurement approach to estimate the operational risk. When modeling the severity of losses in a realistic manner, our preliminary tests indicate that classic distributions are unable to fit the entire range of operational risk data samples (collected from public information sources) well. Then, we propose a piecewise-defined severity distribution (PSD) that combines a parameter form for ordinary losses and a generalized Pareto distribution (GPD) for large losses, and estimate operational risk by the loss distribution approach (LDA) with Monte Carlo simulation. We compare the operational risk measured with piecewise-defined severity distribution based LDA (PSD-LDA) with those obtained from the basic indicator approach (BIA), and the ratios of operational risk regulatory capital of some major international banks with those of Chinese commercial banks. The empirical results reveal the rationality and promise of application of the PSD-LDA for Chinese national commercial banks.

Keywords: Operational risk; LDA; frequency distribution; piecewise-defined severity distribution; Monte Carlo simulation (search for similar items in EconPapers)
Date: 2009
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Citations: View citations in EconPapers (6)

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DOI: 10.1142/S0219622009003727

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