Flexible Dependence Modeling of Operational Risk Losses and Its Impact on Total Capital Requirements

27 Pages Posted: 17 Apr 2013

See all articles by Eike Brechmann

Eike Brechmann

Technische Universität München (TUM)

Claudia Czado

Technische Universität München (TUM)

Sandra Paterlini

University of Trento - Department of Economics and Management

Date Written: March 14, 2013

Abstract

Operational risk data, when available, are usually scarce, heavy-tailed and possibly dependent. In this work, we introduce a model that captures such real-world characteristics and explicitly deals with heterogeneous pairwise and tail dependence of losses. By considering flexible families of copulas, we can easily move beyond modeling bivariate dependence among losses and estimate the total risk capital for the seven- and eight-dimensional distributions of event types and business lines. Using real-world data, we then evaluate the impact of realistic dependence modeling on estimating the total regulatory capital, which turns out to be, as often expected, up to 38% smaller than what the standard Basel approach would prescribe.

Keywords: operational risk, risk capital, dependence modeling, zero inflation, Student's t copula, vine copula

JEL Classification: C1, C5, C30

Suggested Citation

Brechmann, Eike and Czado, Claudia and Paterlini, Sandra, Flexible Dependence Modeling of Operational Risk Losses and Its Impact on Total Capital Requirements (March 14, 2013). Available at SSRN: https://ssrn.com/abstract=2252481 or http://dx.doi.org/10.2139/ssrn.2252481

Eike Brechmann

Technische Universität München (TUM) ( email )

Arcisstrasse 21
Munich, 80333
Germany

Claudia Czado

Technische Universität München (TUM) ( email )

Arcisstrasse 21
Munich, 80333
Germany

Sandra Paterlini (Contact Author)

University of Trento - Department of Economics and Management ( email )

Via Inama 5
Trento, I-38100
Italy

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