Bayesian Methods for Measuring Operational Risk

Discussion Papers in Finance 2000-02

22 Pages Posted: 6 Dec 2000

See all articles by Carol Alexander

Carol Alexander

University of Sussex Business School; Peking University HSBC Business School

Date Written: February 2000

Abstract

The likely imposition by regulators of minimum standards for capital to cover 'other risks' has been a driving force behind the recent interest in operational risk management. Much discussion has been centered on the form of capital charges for other risks. At the same time major banks are developing models to improve internal management of operational proceses, new insurance products for operational risks are being designed and there is growing interest in alternative risk transfer, through OR-linked products.

The purpose of this paper is to introduce Bayesian belief networks (BBNs) and influence diagrams for measuring and managing certain operational risks, such as transaction processing risks and human risks. BBNs lend themselves to the causal modelling of operational processes: if the causal factors can be identified, the Bayesian network will model the influences between these factors and their contribution to the performance of the process. The ability to refine the architecture and parameters of a BBN through back testing is explained, and the paper also demonstrates the use of scenario analysis in a BBN to identify states that lead to maximum operational losses.

Suggested Citation

Alexander, Carol, Bayesian Methods for Measuring Operational Risk (February 2000). Discussion Papers in Finance 2000-02, Available at SSRN: https://ssrn.com/abstract=248148 or http://dx.doi.org/10.2139/ssrn.248148

Carol Alexander (Contact Author)

University of Sussex Business School ( email )

Falmer, Brighton BN1 9SL
United Kingdom

HOME PAGE: http://www.coalexander.com

Peking University HSBC Business School ( email )

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