Scaling Models for the Severity and Frequency of External Operational Loss Data

47 Pages Posted: 24 Jan 2007

See all articles by Hela Dahen

Hela Dahen

Ecole des Hautes Etudes Commerciales de Montreal (HEC)

Georges Dionne

HEC Montreal - Department of Finance

Date Written: January 2007

Abstract

According to Basel II criteria, the use of external data is absolutely indispensable to the implementation of an advanced method for calculating operational capital. This article investigates how the severity and frequencies of external losses are scaled for integration with internal data. We set up an initial model designed to explain the loss severity. This model takes into account firm size, location, and business lines as well as risk types. It also shows how to calculate the internal loss equivalent to an external loss, which might occur in a given bank. OLS estimation results show that the above variables have significant power in explaining the loss amount. They are used to develop a normalization formula. A second model based on external data is developed to scale the frequency of losses over a given period. Two regression models are analyzed: the truncated Poisson model and the truncated negative binomial model. Variables estimating the size and geographical distribution of the banks' activities have been introduced as explanatory variables. The results show that the negative binomial distribution outperforms the Poisson distribution. The scaling is done by calculating the parameters of the selected distribution based on the estimated coefficients and the variables related to a given bank. Frequency of losses of more than $1 million are generated on a specific horizon.

Keywords: Operational risk in banks, scaling, severity distribution, frequency distribution, truncated count data regression models

JEL Classification: G21, G28, C30, C35

Suggested Citation

Dahen, Hela and Dionne, Georges, Scaling Models for the Severity and Frequency of External Operational Loss Data (January 2007). Available at SSRN: https://ssrn.com/abstract=958759 or http://dx.doi.org/10.2139/ssrn.958759

Hela Dahen

Ecole des Hautes Etudes Commerciales de Montreal (HEC) ( email )

3000, Chemin de la Côte-Sainte-Catherine
Montreal, Quebec H3T 2A7
Canada

Georges Dionne (Contact Author)

HEC Montreal - Department of Finance ( email )

3000 Chemin de la Cote-Sainte-Catherine
Montreal, Quebec H3T 2A7
Canada
514-340-6596 (Phone)
514-340-5019 (Fax)

HOME PAGE: http://www.hec.ca/gestiondesrisques/

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
497
Abstract Views
2,618
rank
67,421
PlumX Metrics