Scenario Analysis in the Measurement of Operational Risk Capital: a Change of Measure Approach

July 5, 2012

David Babbel and Kabir Dutta show that while scenario analysis is an important tool for risk measurement, its use in the measurement of operational risk capital has been quite arbitrary and often inaccurate. They propose a method for the measurement of operational risk exposure of an institution using scenario analysis and internal loss data but based on the Change of Measure approach used for asset pricing in financial economics.

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