Scenario Analysis in the Measurement of Operational Risk Capital: A Change of Measure Approach

Submitted on 7th September 2017

At large financial institutions, operational risk is gaining the same importance as market and credit risk in the capital calculation. Although scenario analysis is an important tool for financial risk measurement, its use in the measurement of operational risk capital has been arbitrary and often inaccurate. We propose a method that combines scenario analysis with historical loss data. Using the Change of Measure approach, we evaluate the impact of each scenario on the total estimate of operational risk capital. The method can be used in stress-testing, what-if assessment for scenario analysis, and Loss Given Default estimates used in credit evaluations.

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Journal of Risk and Insurance
Length of Resource
32 pages
Kabir K. Dutta, David F. Babbel
Date Published
Publication Type
Resource Type