A NOTE ON THE ESTIMATION OF THE FREQUENCY AND SEVERITY DISTRIBUTION OF OPERATIONAL LOSSES

The Basel II Capital Accord requires banks to determine the capital charge to account for operational losses. A compound Poisson process with lognormal losses is suggested for this purpose. The paper examines the impact of possibly censored and/or truncated data on the estimation of loss distributions. A procedure for consistent estimation of the severity and frequency distributions based on incomplete data samples is presented. It is also demonstrated that ignoring the peculiarities of available data samples leads to inaccurate value-at-risk estimates that govern the operational risk capital charge.