Model Uncertainty in Operational Risk Modeling Due to Data Truncation: A Single Risk Case
AbstractOver the last decade, researchers, practitioners, and regulators have had intense debates about how to treat the data collection threshold in operational risk modeling. Several approaches have been employed to fit the loss severity distribution: the empirical approach, the “naive” approach, the shifted approach, and the truncated approach. Since each approach is based on a different set of assumptions, different probability models emerge. Thus, model uncertainty arises. The main objective of this paper is to understand the impact of model uncertainty on the value-at-risk (VaR) estimators. To accomplish that, we take the bank’s perspective and study a single risk. Under this simplified scenario, we can solve the problem analytically (when the underlying distribution is exponential) and show that it uncovers similar patterns among VaR estimates to those based on the simulation approach (when data follow a Lomax distribution). We demonstrate that for a fixed probability distribution, the choice of the truncated approach yields the lowest VaR estimates, which may be viewed as beneficial to the bank, whilst the “naive” and shifted approaches lead to higher estimates of VaR. The advantages and disadvantages of each approach and the probability distributions under study are further investigated using a real data set for legal losses in a business unit (Cruz 2002). View Full-Text
Scifeed alert for new publicationsNever miss any articles matching your research from any publisher
- Get alerts for new papers matching your research
- Find out the new papers from selected authors
- Updated daily for 49'000+ journals and 6000+ publishers
- Define your Scifeed now
Yu, D.; Brazauskas, V. Model Uncertainty in Operational Risk Modeling Due to Data Truncation: A Single Risk Case. Risks 2017, 5, 49.
Yu D, Brazauskas V. Model Uncertainty in Operational Risk Modeling Due to Data Truncation: A Single Risk Case. Risks. 2017; 5(3):49.Chicago/Turabian Style
Yu, Daoping; Brazauskas, Vytaras. 2017. "Model Uncertainty in Operational Risk Modeling Due to Data Truncation: A Single Risk Case." Risks 5, no. 3: 49.
Note that from the first issue of 2016, MDPI journals use article numbers instead of page numbers. See further details here.