Lecture23 - 12/2/2010 MGMT 4370 / MGMT 7760 Risk Management...

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12/2/2010 1 MGMT 4370 / MGMT 7760 Risk Management Aparna Gupta Lally School of Management and Technology Office: PITTS 2104 Email: [email protected] Phone: x2757 Operational Risk and Risk Management 2 Aparna Gupta, Lally School, RPI Definition of Operational Risk • The risk of loss resulting from inadequate or failed internal processes, people and systems or from external events . People risk : Incompetence, Fraud, errors of judgment, etc. Process risk : Model risk : Model/methodology error, mark-to-model error, etc. Transaction risk : Execution error, product complexity, booking error, settlement error documentation/contract risk settlement error, documentation/contract risk Operational control risk : Exceeding limits, security risk, volume risk Systems and Technology risk : System failure, computer breakdowns, programming error, information risk, telecommunications failure, etc. Legal risk : Exposure to fines, penalties, punitive damages from supervisory actions, private settlements. • It does NOT include business and reputation risk. 3 Aparna Gupta, Lally School, RPI Eight Key Elements for Operational Risk Management 1. Setting policy - establish clear guidelines for practices that control or reduce operational risk 2. Identifying risk on the basis of agreed-upon terminology 3. Constructing business process maps –prov ide transparency to management and auditors 4. Building best-practices measurement methodology - quantitative methodology based on historical loss experience and scenario analysis, to derive loss frequency and loss severity distributions 5. Providing exposure management - appropriate actions to hedge operational risk or mitigate the risk 4 Aparna Gupta, Lal y School, RPI Eight Key Elements for Operational Risk Management 6. Installing a timely reporting capability – what to report usefully, to whom and with what frequency 7. Performing risk analysis (including stress testing) – Appropriate measures , up-to-date databases of internal and industry-wide operational loss data, well-designed scenario analysis and understanding of key risk drivers in each business line. – All these feed into calculation of Operational Value-at- Risk (OpVaR) . 8. Allocating economic capital as a function of operational risk - attribution of operational risk capital to every business. 5 Aparna Gupta, Lal y School, RPI Managing Operational Risk • Mechanism for attributing capital to operational risk should be risk-based, transparent, scalable and fair. • Capital requirements should vary directly with levels of verifiable risk, provide incentive to manage operational risk, improve operational decisions, and increase risk-adjusted return on capital.
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This note was uploaded on 01/27/2011 for the course MGMT 4370 taught by Professor Gupta during the Fall '10 term at Rensselaer Polytechnic Institute.

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Lecture23 - 12/2/2010 MGMT 4370 / MGMT 7760 Risk Management...

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