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Using a time series approach to correct serial correlation in operational risk capital calculation

Author

Listed:
  • Dominique Guegan

    () (CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique)

  • Bertrand Hassani

    () (CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique)

Abstract

The advanced measurement approach requires financial institutions to develop internal models to evaluate regulatory capital. Traditionally, the loss distribution approach (LDA) is used, mixing frequencies and severities to build a loss distribution function (LDF). This distribution represents annual losses; consequently, the 99.9th percentile of the distribution providing the capital charge denotes the worst year in a thousand. The traditional approach approved by the regulator and implemented by financial institutions assumes the losses are independent. This paper proposes a solution to address the issues arising when autocorrelations are detected between the losses, by using time series. Thus, the losses are aggregated periodically and several models are adjusted using autoregressive models, autoregressive fractionally integrated and Gegenbauer processes considering various distributions fitted on the residuals. Monte Carlo simulation enables the construction of the LDF, and the computation of the relevant risk measures. These dynamic approaches are compared with static traditional methodologies in order to show their impact on the capital charges, using several data sets. The construction of the related LDFs and the computation of the capital charges permit complying with the regulation. Besides, capturing simultaneously autocorrelation phenomena and large losses by fitting adequate distributions on the residuals, provide an alternative to the arbitrary selection of the LDA.

Suggested Citation

  • Dominique Guegan & Bertrand Hassani, 2013. "Using a time series approach to correct serial correlation in operational risk capital calculation," Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) halshs-00771387, HAL.
  • Handle: RePEc:hal:cesptp:halshs-00771387
    Note: View the original document on HAL open archive server: https://halshs.archives-ouvertes.fr/halshs-00771387v2
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    References listed on IDEAS

    as
    1. Chernobai, Anna & Yildirim, Yildiray, 2008. "The dynamics of operational loss clustering," Journal of Banking & Finance, Elsevier, vol. 32(12), pages 2655-2666, December.
    2. repec:cup:jfinqa:v:46:y:2011:i:06:p:1683-1725_00 is not listed on IDEAS
    3. Dominique Guegan & Bertrand Hassani, 2011. "Operational risk: A Basel II++ step before Basel III," Post-Print halshs-00639484, HAL.
    4. Jarque, Carlos M. & Bera, Anil K., 1980. "Efficient tests for normality, homoscedasticity and serial independence of regression residuals," Economics Letters, Elsevier, vol. 6(3), pages 255-259.
    5. repec:hal:wpaper:halshs-00722029 is not listed on IDEAS
    6. Allen, Linda & Bali, Turan G., 2007. "Cyclicality in catastrophic and operational risk measurements," Journal of Banking & Finance, Elsevier, vol. 31(4), pages 1191-1235, April.
    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    Operational risk; time series; Gegenbauer processes; Monte Carlo; risk measures; Gegenbauer processus; Risque opérationnel; séries chronologiques; mesure du risque;

    JEL classification:

    • C18 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Methodolical Issues: General

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