Operational Risk Models

Overview

Operational Risk is generally considered hard to model. This can be attributed to multiple factors, including both the heterogeneous nature of the risks under the operational umbrella, to the lack of quality operational risk data.

For banks, the Basel Accords provide an framework for measuring operational risk. (see Basel Operational Risk framework)

Approaches

• Reduced Form (Top Down) - does not try to explain the causes of the risk, but may try to correlate it with a set of factors.
• Structural (Bottom Up) - tries to break the risk down to factors that cause or explain the risk.