Operational Risk FRM L2 Part 1of3 2 Nov

7/30/2019 Operational Risk FRM L2 Part 1of3 2 Nov

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Operational Risk for FRM L2 (Part

1/2)By Shivgan Joshi

http://stockcreditfinancecfa.blogspot.in/
http://stockcreditfinancecfa.blogspot.in/http://stockcreditfinancecfa.blogspot.in/http://stockcreditfinancecfa.blogspot.in/


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Disclaimer

All terms like FRM are copyright to GARPInstitute

This video is intended to learning, researchand reporting about FRM Exam

I dont represent FRM Institute, Nor I amauthorized trainer or endorsed by GARP/FRM

I dont claim or guarantee accuracy of theinformation


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About the Author

Instructor has 70% score on BAT, in aprox top 90percentile globally

Cleared CFA L1, FRM L1 exams Have experience of teaching on Wiziq, taking

classes on GRE and GMAT for the past 1 year

Websites www.freegregmatclass.com stockcreditfinancecfa.blogspot.in
http://www.freegregmatclass.com/http://www.freegregmatclass.com/http://www.freegregmatclass.com/


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Index

1. Economic Capital Modeling2. Model Risk3. Liquidity Risk4. Enterprise risk management5. Risk from Loss of Data6. Distributions, Analysis & Fitting of Operational loss

data7. Dealer Bankers & BASEL Class 28. Risk Aggregation


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Introduction

Overview of the examSensitizes you with various topics


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Economic Capital Modeling

RAROC= (Revenues EL Expenses+Return on Economiccapital+- Transfer price)/EC

Capital Attributed to 3 Risks

Credit capital charge= capital factor * market value of position Risk Aggregation: 5 methods

Two of them which are interesting are:

Variance Covariance method

Copula: combines marginal probability into joint prob


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Spectral & Distorted Risk Measure

Risk measures Most famous risk measure is VAR

http://en.wikipedia.org/wiki/Distortion_risk_measure http://en.wikipedia.org/wiki/Spectral_risk_measure
http://en.wikipedia.org/wiki/Spectral_risk_measurehttp://en.wikipedia.org/wiki/Spectral_risk_measurehttp://en.wikipedia.org/wiki/Spectral_risk_measurehttp://en.wikipedia.org/wiki/Spectral_risk_measure


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Variance Covariance matrix Risk aggregation http://en.wikipedia.org/wiki/Covariance_matrix Image source wiki


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Model Risk

Quantifying Model risk Unknown parameters, correlations, mixing,and distribution risk

Unknown parameters have Chi Squaredistribution


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Liquidity Risk

Liquidation value of Assets Complex Formula Cost of liquidity Risk

Funding Risk http://en.wikipedia.org/wiki/Gini_coefficient http://en.wikipedia.org/wiki/Lorenz_curve
http://en.wikipedia.org/wiki/Gini_coefficienthttp://en.wikipedia.org/wiki/Lorenz_curvehttp://en.wikipedia.org/wiki/Lorenz_curvehttp://en.wikipedia.org/wiki/Gini_coefficient


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Quant of liquidity risk

LVAR/VAR1. Mid value for spread

2. Stochastic Spread

Endogenous prices

Use elasticity term, LVAR=VAR*(1-E*( N/N)) E=( P/P)/( N/N)


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Loss Distribution Approach (LDA)

Weighting data points Frequency distributions

Severity Parametric tales using Peaks over thresholdsand Generalized Pareto Distribution

Freq and Severity convoluted to get final lossdistribution


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Risk from Loss of Data

Operational data tough to get

Standard error for non parametric estimator:(1/f(q))*(p(1-p)/n)^0.5

Extrapolation using EVT & GPD


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Analysis of Operational Loss data

Tail Plots: Log (1-F(x)) vs log x where x is data pointsand F() is the distribution function

Mean access plots: Subtracting threshold from averagethe average of all loss greater than threshold

Fitting distribution of Operation Loss Data Peaks over threshold Hill estimator


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Analysis of Operational Loss data

Tail parameter estimate: HKKP (researchpapers): E( (k))= +ck

The graph of tail parameter estimator forvarious k is referred to DedH plots

Hill Plots

Heavy Tail Light tail

Burr Exponential

Loggamma Gamma

Loglogistic Log normal

Pareto-GPD Weibull


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BASEL 2

Three options for credit Risk1. Standardized Approach

2. IRB foundation

3. IRB advanced

Three Pillar

1. Min capital requirements: Quant assessment

2. Supervisory review: Formal role of regulators

3. Market Discipline: Disclosers for regular capital requirements

Tier 1,2, 3 capital


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Standard error for non parametricestimator

f=the probability density function Q p = the quantile associated with theprobability

1 (1 )( ) p

p qSE f q n


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Capital requirement for credit risk

Capital requirement (K) = (conditional EL EL)* (maturity adjustment)

1 Rdownturn LGD N{ ( ) (0.999)} .....

1-R 1-RG PD G LGD


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Market Risk Capital Charge


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Liquidation Value of assets


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LVAR/VAR

Formula


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DedH

Rejecting null hypothesis that underlyingdistribution for loss data is light tailed


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HKKP

Hill estimator


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Class 2

Class 2: Alternative OR, Loss data, BASEL 2&3, Risk Aggregation, Enterprise riskmanagement


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Conclusion

10 minutes introduction to FRM OperationalRisk Module 1 of 2


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References

FRM GARP reading info

Documents

Operational Risk FRM L2 Part 1of3 2 Nov