The Issues with the Standardized Measurement Approach and a Potential Future Direction for Operational Risk Capital Modeling

12 Pages Posted: 30 Aug 2017

Date Written: August 29, 2017

Abstract

Tensions have risen in the area of operational risk following the standardized measurement approach (SMA) proposal and the possible removal of the advanced measurement approach (AMA). These tensions, created by the desire for simplicity and transparency on the one hand and risk sensitivity on the other, are well reflected in many recent articles, which mostly criticize the SMA but praise the AMA. Here, we look at the criticism and praise in two current technical papers and note that although the validity of the SMA criticism is demonstrated with analytical precision, the praise for the AMA appears to lack similar justification. The reason for this is that the simplicity and transparency of the SMA allow objective analysis, whereas the complexity and opacity of the AMA do not. Moving on from this, it is proposed that a single, universal loss distribution approach-type (LDA-type) model may be the way forward for the next generation of operational risk capital models. This way, simplicity and transparency are retained as model qualities, while risk sensitivity, albeit at the entity level, is also improved over that of the SMA due to the nature of the LDA.

Keywords: standardized measurement approach (SMA), advanced measurement approach (AMA), loss distribution approach (LDA), operational risk, capital model

Suggested Citation

Cohen, Ruben, The Issues with the Standardized Measurement Approach and a Potential Future Direction for Operational Risk Capital Modeling (August 29, 2017). Journal of Operational Risk, 12(3), 1–12 DOI:10.21314/JOP.2017.203 . Available at SSRN: https://ssrn.com/abstract=3028545

Ruben Cohen (Contact Author)

Independent ( email )

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