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Operational Risk toward Basel III: Best Practices and Issues in Modeling, Management, and Regulation

Book Description

This book consists of chapters by contributors (well-known professors, practitioners, and consultants from large and well respected money management firms within this area) offering the latest research in the OpRisk area. The chapters highlight how operational risk helps firms survive and prosper by givingreaders the latest, cutting-edge techniques in OpRisk management. Topics discussed include: Basel Accord II, getting ready for the New Basel III, Extreme Value Theory, the new capital requirements and regulations in the banking sector in relation to financial reporting (including developing concepts such as OpRisk Insurance which wasn't a part of the Basel II framework). The book further discussed quantitative and qualitative aspects of OpRisk, as well as fraud and applications to the fund industry.

Table of Contents

  1. Title Page
  2. Copyright Page
  3. Foreword
  4. About the Editor
  5. Acknowledgements
  6. About the Contributors
  7. PART One: Operational Risk Measurement: Qualitative Approaches
    1. CHAPTER 1 - Modeling Operational Risk Based on Multiple Experts’ Opinions
      1. 1.1 INTRODUCTION
      2. 1.2 OVERVIEW OF THE AMA MODELS
      3. 1.3 USING EXPERTS’ OPINIONS TO MODEL OPERATIONAL RISK: A PRACTICAL BUSINESS CASE
      4. 1.4 COMBINING EXPERTS’ OPINIONS
      5. 1.5 SUPRA-BAYESIAN MODEL FOR OPERATIONAL RISK MODELING
      6. 1.6 CONCLUSION
      7. NOTES
      8. REFERENCES
    2. CHAPTER 2 - Consistent Quantitative Operational Risk Measurement
      1. 2.1 INTRODUCTION
      2. 2.2 CURRENT PRACTICES OF OPERATIONAL RISK MEASUREMENT AND REGULATORY APPROACHES
      3. 2.3 MAIN MEASUREMENT CHALLENGES OF LDA
      4. 2.4 CONCLUSION
      5. APPENDIX
      6. NOTES
      7. REFERENCES
    3. CHAPTER 3 - Operational Risk Based on Complementary Loss Evaluations
      1. 3.1 INTRODUCTION
      2. 3.2 LOSS DISTRIBUTION APPROACH
      3. 3.3 COMPLEMENTARY LOSS EVALUATIONS
      4. 3.4 SUBJECTIVE INFORMATION ANALYSIS
      5. 3.5 INTEGRATION OF THE SUBJECTIVE AND THE QUANTITATIVE ANALYSIS
      6. 3.6 CONCLUSION
      7. REFERENCES
    4. CHAPTER 4 - Can Operational Risk Models Deal with Unprecedented Large Banking Losses?
      1. 4.1 INTRODUCTION
      2. 4.2 WHY SOME UNEXPECTED LOSSES CANNOT BE STUDIED IN SCENARIO GROUPS
      3. 4.3 REQUIRED FEATURES FOR A NEW METHODOLOGY TO EXPLORE UNPRECEDENTED CATASTROPHES
      4. 4.4 USING STOCHASTIC DYNAMICS TO DRIVE EVENTS IN A NETWORK COMBINING ACTORS
      5. 4.5 OBTAINING RISK-GENERATING NODES IN A NETWORK GRAPH
      6. 4.6 GENERATING LOSSES IN A STOCHASTIC MULTISTEP DYNAMIC
      7. 4.7 VERIFICATION REQUIREMENTS FOR MODEL DYNAMICS
      8. 4.8 REQUIREMENTS OF MODEL EVOLUTION BY LEARNING
      9. 4.9 CONCLUSION
      10. REFERENCES
    5. CHAPTER 5 - Identifying and Mitigating Perceived Risks in the Bank Service Chain: A New Formalization Effort to Address the Intangible and Heterogeneous Natures of Knowledge-Based Services
      1. 5.1 INTRODUCTION
      2. 5.2 BANKS IN THE POST-SUBPRIME ERA: AN IMPORTANT SECTOR IN TURMOIL
      3. 5.3 NOTION OF PERCEIVED RISK: LITERATURE REVIEW
      4. 5.4 BANK SERVICE CHAIN: CHAIN OF SERVICES AND OF RISK EVENTS
      5. 5.5 CONTROL SYSTEM DESIGNED TO ADDRESS THE INTANGIBLE NATURE OF SERVICE RISKS
      6. 5.6 APPLICATION OF THE TEID MODEL: THE SOCGÉN CASE
      7. 5.7 CONCLUSION
      8. REFERENCES
    6. CHAPTER 6 - Operational Risk and Stock Market Returns: Evidence from Turkey
      1. 6.1 INTRODUCTION
      2. 6.2 OPERATIONAL LOSSES AND THE BANKING SECTOR IN TURKEY
      3. 6.3 REACTION OF STOCK RETURNS TO OPERATIONAL RISK EVENTS
      4. 6.4 CONCLUSION
      5. NOTES
      6. REFERENCES
  8. PART Two: Operational Risk Measurement: Quantitative Approaches
    1. CHAPTER 7 - Integrating Op Risk into Total VaR
      1. 7.1 INTRODUCTION
      2. 7.2 A BRIEF REVIEW OF INTEGRATED RISK MANAGEMENT IN THE PRESENCE OF OPR
      3. 7.3 CLOSED-FORM APPROXIMATION BASED ON MSHM IN THE MODERATELY HEAVY-TAILED CASE
      4. 7.4 SIMULATION RESULTS
      5. 7.5 CONCLUSION
      6. NOTES
      7. REFERENCES
    2. CHAPTER 8 - Importance Sampling Techniques for Large Quantile Estimation in the Advanced Measurement Approach
      1. 8.1 INTRODUCTION
      2. 8.2 PRELIMINARIES: POISSON MIXTURES AND IMPORTANCE SAMPLING
      3. 8.3 MODERATELY HEAVY-TAILED CASE: LOGNORMAL SEVERITY
      4. 8.4 HEAVY-TAILED CASE: PARETO SEVERITY
      5. 8.5 SIMULATION RESULTS
      6. 8.6 CONCLUSION
      7. REFERENCES
    3. CHAPTER 9 - One-Sided Cross-Validation for Density Estimation with an Application to Operational Risk
      1. 9.1 INTRODUCTION
      2. 9.2 ONE-SIDED CROSS-VALIDATION METHOD FOR DENSITY ESTIMATION
      3. 9.3 ASYMPTOTIC THEORY
      4. 9.4 FINITE SAMPLE PERFORMANCE
      5. 9.5 PRACTICAL REMARKS AND DATA APPLICATIONS
      6. 9.6 CONCLUSION
      7. NOTES
      8. REFERENCES
    4. CHAPTER 10 - Multivariate Models for Operational Risk: A Copula Approach Using Extreme Value Theory and Poisson Shock Models
      1. 10.1 INTRODUCTION
      2. 10.2 STANDARD LDA APPROACH
      3. 10.3 AGGREGATION VIA COPULA
      4. 10.4 EMPIRICAL ANALYSIS
      5. 10.5 CONCLUSION
      6. REFERENCES
    5. CHAPTER 11 - First-Order Approximations to Operational Risk: Dependence and Consequences
      1. 11.1 INTRODUCTION
      2. 11.2 FROM PARETO COPULAS TO PARETO LÉVY COPULAS
      3. 11.3 UNDERSTANDING THE DEPENDENCE STRUCTURE
      4. 11.4 APPROXIMATING TOTAL OpVaR
      5. 11.5 CONCLUSION
      6. REFERENCES
  9. PART Three: Operational Risk Management and Mitigation
    1. CHAPTER 12 - Integrating “Management” into “OpRisk Management”
      1. 12.1 INTRODUCTION
      2. 12.2 LIMITED SCOPE OPERATIONAL RISK MANAGEMENT UNDER BASEL II
      3. 12.3 MANAGEMENT PERSPECTIVE IN OPERATIONAL RISK MANAGEMENT
      4. 12.4 RENDERING OPERATIONAL RISK MANAGEMENT OPERATIONALLY MANAGEABLE
      5. 12.5 RECOMMENDATIONS AND OUTLOOK
      6. NOTES
      7. REFERENCES
    2. CHAPTER 13 - Operational Risk Management: An Emergent Industry
      1. 13.1 INTRODUCTION
      2. 13.2 OPERATIONAL RISK MANAGEMENT AS ENFORCED SELF-REGULATION
      3. 13.3 OPERATIONAL RISK: BIRTH OF AN INDUSTRY
      4. 13.4 CONCLUSION
      5. REFERENCES
    3. CHAPTER 14 - OpRisk Insurance as a Net Value Generator
      1. 14.1 INTRODUCTION
      2. 14.2 TREATMENT OF INSURANCE CONCEPTS UNDER BASEL II’S OPRISK CATEGORY
      3. 14.3 A MORE ENCOMPASSING VIEW ON INSURANCE CONCEPTS FOR OPRISK MANAGEMENT
      4. 14.4 RISK, COST OF CAPITAL, AND SHAREHOLDER VALUE
      5. 14.5 OPTIMIZATION OF THE TOTAL COST OF RISK
      6. 14.6 CONCLUSIONS, RECOMMENDATIONS, AND OUTLOOK FOR FURTHER RESEARCH
      7. NOTES
      8. REFERENCES
    4. CHAPTER 15 - Operational Risk Versus Capital Requirements under New Italian Banking Capital Regulation: Are Small Banks Penalized?
      1. 15.1 INTRODUCTION
      2. 15.2 OPERATIONAL RISK CAPITAL REQUIREMENTS UNDER ITALIAN INSTRUCTIONS FOR BANKS
      3. 15.3 DATA
      4. 15.4 METHODOLOGY
      5. 15.5 RESULTS
      6. 15.6 CONCLUSION
      7. NOTE
      8. REFERENCES
    5. CHAPTER 16 - Simple Measures for Operational Risk Reduction? An Assessment of Implications and Drawbacks
      1. 16.1 INTRODUCTION
      2. 16.2 LOSS PROCESS AND CONTRACTS
      3. 16.3 PRICING OF INSURANCE CONTRACTS
      4. 16.4 RISK REDUCTION
      5. 16.5 MONTE CARLO SIMULATION
      6. 16.6 POLICY IMPLICATIONS
      7. 16.7 CONCLUSION
      8. NOTES
      9. REFERENCES
  10. PART Four: Issues in Operational Risk Regulation and the Fund Industry
    1. CHAPTER 17 - Toward an Economic and Regulatory Benchmarking Indicator for Banking Systems
      1. 17.1 INTRODUCTION
      2. 17.2 IMPORTANCE OF A SOUND LEGAL FRAMEWORK
      3. 17.3 LITERATURE ON STOCK MARKET RETURNS AND COUNTRY RISK
      4. 17.4 MARKET RISK AND ECONOMIC CAPITAL
      5. 17.5 SYSTEMIC EARNINGS AT RISK MODEL
      6. 17.6 INTERNATIONAL COMPARATIVE ADVANTAGE IN BANKING SYSTEMS
      7. 17.7 MODEL AND METHODOLOGY
      8. 17.8 ECONOMIC AND REGULATORY CAPITAL MODEL
      9. 17.9 DISCUSSION
      10. 17.10 CONCLUSION
      11. NOTES
      12. REFERENCES
    2. CHAPTER 18 - Operational Risk Disclosure in Financial Services Firms
      1. 18.1 INTRODUCTION
      2. 18.2 RISK DISCLOSURE STUDIES
      3. 18.3 REGULATORY GUIDELINES ON RISK DISCLOSURE
      4. 18.4 STUDY OF OPERATIONAL RISK DISCLOSURES
      5. 18.5 CONCLUSION
      6. NOTES
      7. REFERENCES
    3. CHAPTER 19 - Operational Risks in Payment and Securities Settlement Systems: A Challenge for Operators and Regulators
      1. 19.1 INTRODUCTION
      2. 19.2 OVERVIEW OF THE REGULATORY APPROACHES TO OPERATIONAL RISK IN PCSSs
      3. 19.3 IMPLICATIONS OF OPERATIONAL RISK FOR PAYMENT, CLEARING, AND SETTLEMENT SYSTEMS
      4. 19.4 CONCLUSION
      5. NOTES
      6. REFERENCES
    4. CHAPTER 20 - Actual and Potential Use of Unregulated Financial Institutions for Transnational Crime
      1. 20.1 HISTORY OF THE SUBPRIME CRISIS AND THE ROLE OF HEDGE FUNDS, FINANCE COMPANIES AND PLANNERS, AND MORTGAGE BROKERS
      2. 20.2 CURRENT PRUDENTIAL REGULATORY SYSTEM GOVERNING NBFIs
      3. 20.3 ROLE OF HEDGE FUNDS
      4. 20.4 POTENTIAL FOR SYSTEMIC RISK AND CONTAGION FROM HEDGE FUNDS, MORTGAGE LENDERS, AND UNREGULATED FINANCE COMPANIES
      5. 20.5 LACK OF PROTECTION OF BORROWERS AND LENDERS EXPOSED BY THE SUBPRIME CREDIT CRISIS
      6. 20.6 MECHANISMS FOR TRANSNATIONAL CRIME
      7. 20.7 CONCLUSION: A REGULATORY BLACK HOLE AND A FIELD RIFE FOR FUTURE RESEARCH
      8. NOTES
      9. REFERENCES
    5. CHAPTER 21 - Case Studies in Hedge Fund Operational Risks: From Amaranth to Wood River
      1. 21.1 INTRODUCTION
      2. 21.2 MARKET RISK AND OPERATIONAL RISK
      3. 21.3 DUE DILIGENCE AND MANAGER TRANSPARENCY
      4. 21.4 FOUR RECENT FRAUDS HIGHLIGHT THE IMPORTANCE OF OPERATIONAL RISKS
      5. 21.5 RED FLAGS IN THE HEDGE FUND INDUSTRY
      6. 21.6 PROPOSAL FOR PARTIAL TRANSPARENCY
      7. 21.7 CONCLUSION
      8. REFERENCES
    6. CHAPTER 22 - A Risk of Ruin Approach for Evaluating Commodity Trading Advisors
      1. 22.1 INTRODUCTION
      2. 22.2 DATA
      3. 22.3 METHODOLOGY
      4. 22.4 RESULTS
      5. 22.5 CONCLUSION
      6. ACKNOWLEDGMENTS
      7. REFERENCES
    7. CHAPTER 23 - Identifying and Mitigating Valuation Risk in Hedge Fund Investments
      1. 23.1 INTRODUCTION
      2. 23.2 WHAT IS OPERATIONAL VALUATION RISK?
      3. 23.3 VALUATION RISK: STRATEGY RELATED
      4. 23.4 VALUATION RISK: CONTROL RELATED
      5. 23.5 EVALUATING AND MITIGATING VALUATION RISK
      6. 23.6 SUMMARY AND SYNTHESIS OF SOUND PRACTICE GUIDELINES FOR FUND VALUATION FROM AIMA AND THE MFA
      7. 23.7 CONCLUSION
      8. REFERENCES
  11. Index