A Tale of Tails: An Empirical Analysis of Loss Distribution Models for Estimating Operational Risk Capital

Abstract:     
Operational risk is being recognized as an important risk component for financial institutions as evinced by the large sums of capital that are allocated to mitigate this risk. Therefore, risk measurement is of paramount concern for the purposes of capital allocation, hedging, and new product development for risk mitigation. We perform a comprehensive evaluation of commonly used methods and introduce new techniques to measure this risk with respect to various criteria. We find that our newly introduced techniques perform consistently better than the other models we tested.

Number of Pages in PDF File: 93

Keywords: exploratory data analysis, operational risk, g-and-h distribution, goodness-of-fit, skewness-kurtosis, risk measurement, extreme value theory, peak-over-threshold method, generalized Pareto distribution, truncated lognormal distribution, loglogistic distribution

JEL Classification: G10, G20, G21, D81

working papers series