Quantitative Operational Risk Management

The New Basel Capital Accord presents a framework for measuring operational risk which includes four degrees of complexity. In this paper we focus on a mathematical description of the Loss Distribution Approach (LDA), being the more rigorous and potentially more accurate approach towards which most (advanced) institutions will be striving. In particular the aim of this paper is to show how a basic quantitative interpretation of LDA, focusing on the mere numerical measurement of operational risk, may be generalized to include factors of some practical importance. These include; endogenization of the operational risk event via the concept of key risk driver (akin to a formalization of scorecard approaches), a flexible co-dependence structure and a clear statement of the objective and scope of the operational risk manager.