The Journal of Operational Risk, Vol. 7, No. 1, Spring 2012.
33 Pages Posted: 31 Aug 2010 Last revised: 10 Feb 2012
Date Written: February 1, 2012
Among operational risk practitioners there is some confusion about the implications of the loss data collection threshold and the estimation of "truncated" or "shifted" distributions. Claims that "shifted" models result in biased parameter estimates rely on the premise that the "true" model is known to be "truncated" and do not objectively evaluate "shifted" distributions. We systematically analyze the performance of "shifted" and "truncated" lognormal models and illustrate the use of Vuong's LR test for model selection. We conclude that truncated and shifted lognormal models are equally valid or invalid approaches for estimating loss severity with a data collection threshold.
Keywords: Operational risk, Regulatory capital, Loss distribution, Data truncation, Shifted distribution, Vuong's test, Severity distribution, Basel II
JEL Classification: C13, G20, G21, G32
Suggested Citation: Suggested Citation
Cavallo, Alexander and Rosenthal, Benjamin and Wang, Xiao and Yan, Jun, Treatment of the Data Collection Threshold in Operational Risk: A Case Study with the Lognormal Distribution (February 1, 2012). The Journal of Operational Risk, Vol. 7, No. 1, Spring 2012.. Available at SSRN: https://ssrn.com/abstract=1668939 or http://dx.doi.org/10.2139/ssrn.1668939
By Mo Chaudhury