Operational Risk based on Complementary Loss Evaluations

In this chapter we develop the Complementary Loss Evaluations (CLE) framework for computing the capital charge of a bank for operational risk where CLE refers to subjective and quantitative statistical/actuarial methods for modeling the loss distribution. In this framework, the capital charge is calculated using a Value-at-Risk measure. In the first part, we introduce the quantitative statistical/actuarial method based on the Mixed Frequency Models or Compound Frequency Models as a common framework where both the subjective analysis and the quantitative analysis could be integrated. In the second part of the paper, we give a detailed description of the subjective method to evaluate losses. In particular, we show how to compute the aggregate loss distribution by compounding the loss severity distribution and the loss frequency distribution based on the self risk assessment approach. Finally, we propose a Bayesian approach to merge the qualitative and the quantitative loss distributions.