Page 12 - Azerbaijan State University of Economics

THE JOURNAL OF ECONOMIC SCIENCES: THEORY AND PRACTICE, V.81, # 2, 2024, pp. 4-29

Figure 04: Distribution of Operational Risk Losses
Source : Wong, M. C. Y. Bubble value at risk: A countercyclical risk management
approach John Wiley & Sons, Singapore. 2013, p. 189.

Since OpVaR is typically measured at a one-year horizon, density f (n) is the
probability that n events will occur annually, and then we use a process called
convolution to combine f (n) andg (x|n = 1) to derive the loss distribution, this can
be done simplistically by scheduling, which is to systematically record all possible
transitions in severity for each n (Hasan Dinçer, 2017).

The amount of loss at the tail is then quantified at 99.9% which represents the OpVaR. We
consider the area outside OpVaR to be an extraordinary loss XL. The area between EL and
XL gives an unexpected loss of UL, from the chart we find that: (OpVaR = EL+UL). Under
the Basel II loss allocation approach, banks' operational risk capital is a function of the sum
of the OpVaR of all line-of-business groups against the event type (BL-ET) (Ainura
Tursunalieva, Nonparametric estimation of operational value-at-risk (OpVaR), 2016).

OpVaR is defined as 99.9% over a one-year horizon, using OpVaR for regulatory capital.
Many experts believe that the OpVaR model cannot be meaningfully designed due to data
scarcity and is just a check mark to meet regulatory requirements (Ainura Tursunalieva,
2016).

In the absence of an effective model, the autonomy of a vigilant risk manager is crucial,
for example operational risk events tend to occur in a (interconnected) sequence - the
Enron Worldcom scandals occurred around the same time, and similarly as recently in
2012 the Libor manipulation scandal, the money laundering of a UK bank involving
Mexican drug lords, and another UK bank's alleged dealings with Iran (a country under
US sanctions). This was no coincidence - the scandal will lead to increased scrutiny by
regulators, leading to more scandals being revealed, a vigilant risk manager who closely
monitors events would have realised operational risk capital by the amount of loss
expected from similar recent events (Blackhurst, 2022)

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