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Operational Risk Aggregation Based on Business Line Dependence: A Mutual Information Approach

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  • Wenzhou Wang
  • Limeng Shi
  • Xiaoqian Zhu

Abstract

The dependencies between different business lines of banks have serious effects on the accuracy of operational risk estimation. Furthermore, the dependencies are far more complicated than simple linear correlation. While Pearson correlation coefficient is constructed based on the hypothesis of a linear association, the mutual information that measures all the information of a random variable contained in another random variable is a powerful alternative. Based on mutual information, the generalized correlation coefficient which can capture both linear and nonlinear correlation can be derived. This paper models the correlation between business lines by mutual information and normal copula. The experiment on a real‐world Chinese bank operational risk data set shows that using mutual information to model the dependencies between business lines is more reasonable than linear correlation.

Suggested Citation

  • Wenzhou Wang & Limeng Shi & Xiaoqian Zhu, 2016. "Operational Risk Aggregation Based on Business Line Dependence: A Mutual Information Approach," Discrete Dynamics in Nature and Society, John Wiley & Sons, vol. 2016(1).
    • Handle: RePEc:wly:jnddns:v:2016:y:2016:i:1:n:6546318
    DOI: 10.1155/2016/6546318
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    References listed on IDEAS

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