Economics, Econometrics and Finance
4 years ago

Low Correlation in Operational Risk Opens Door to Massive Diversification Effects

MPRA Paper
The Correlation Problem in Operational Risk
Antoine Frachot, Thierry Roncalli, Eric Salomon

Paper Summary

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The study shows that when using certain models to predict operational risk, the total losses are usually low. The research found that the correlation between two total losses is typically less than 5%, allowing for significant diversification benefits. This means that adding up capital charges contradicts the expected correlation pattern in the standard model.