The Quantification of Operational Risk Using Internal Data, Relevant External Data and Expert Opinion

Abstract

To quantify an operational risk capital charge under Basel II, many banks adopt a Loss Distribution Approach. Under this approach, quantification of the frequency and severity distributions of operational risk involves the bank's internal data, expert opinions and relevant external data. In this paper we suggest a new approach, based on a Bayesian inference method, that allows for a combination of these three sources of information to estimate the parameters of the risk frequency and severity distributions.

Keywords: Operational Risk, Basel II, Loss Distribution Approach, Bayesian inference, Advanced Measurement Approach, Quantitative Risk Management, generalized inverse Gaussian distribution

JEL Classification: C00, G00