Loss Distribution Approach for Operational Risk Capital Modelling under Basel II: Combining Different Data Sources for Risk Estimation

The management of operational risk in the banking industry has undergone significant changes over the last decade due to substantial changes in operational risk environment. Globalization, deregulation, the use of complex financial products and changes in information technology have resulted in exposure to new risks very different from market and credit risks. In response, Basel Committee for banking Supervision has developed a regulatory framework, referred to as Basel II, that introduced operational risk category and corresponding capital requirements. Over the past five years, major banks in most parts of the world have received accreditation under the Basel II Advanced Measurement Approach (AMA) by adopting the loss distribution approach (LDA) despite there being a number of unresolved methodological challenges in its implementation. Different approaches and methods are still under hot debate. In this paper, we review methods proposed in the literature for combining different data sources (internal data, external data and scenario analysis) which is one of the regulatory requirement for AMA

Generalized Evidence Theory

Conflict management is still an open issue in the application of Dempster Shafer evidence theory. A lot of works have been presented to address this issue. In this paper, a new theory, called as generalized evidence theory (GET), is proposed. Compared with existing methods, GET assumes that the general situation is in open world due to the uncertainty and incomplete knowledge. The conflicting evidence is handled under the framework of GET. It is shown that the new theory can explain and deal with the conflicting evidence in a more reasonable way.Comment: 39 pages, 5 figure