Operational Risk and Insurance: Quantitative and Qualitative Aspects

Abstract:     
This paper incorporates insurance contracts into an operational risk model based on idiosyncratic and common shocks. A key feature of the approach is the explicit modelling of residual risk inherent in insurance contracts, such as counterparty default, payment uncertainty and liquidity risk due to delayed payments. Compared to the standard haircut approach, the net loss distribution exhibits a larger weight on the tail. Thereby an underestimation of extreme losses and loss clusters is avoided. The difference between the models is statistically significant for the means and the 99.9% - quantiles of the distribution.

Keywords: Operational risk, risk management, insurance, simulation

JEL Classifications: C16, C69, G18, G21, G22

Working Paper Series