PRMIA INSTITUTE AWARDS 2007 NEW FRONTIERS IN RISK MANAGEMENT PRIZE FOR OPERATIONAL RISK RESEARCH PAPER

Wilmington, DE - 12 April 2007

At the 2007 Enterprise Risk Management Symposium, the PRMIA Institute announced the selection of Klaus Böcker and Claudia Klüppelberg as the winners of its 2007 New Frontiers in Risk Management Award for their research paper entitled “Multivariate Models for Operational Risk.” Mr. Böcker is Senior Risk Controller at HypoVereinsbank AG in Munich. In this capacity, one of his primary responsibilities is overseeing the quantitative aspects of HVB's economic capital model. Professor Klüppelberg holds the chair of Mathematical Statistics at the Center for Mathematical Sciences at the Munich University of Technology.

This latest paper is a follow-up to Mr. Böcker’s and Professor Klüppelberg’s research paper published in the December 2005 issue of RISK, in which they presented a simple approximation of operational Value-at-Risk (“OpVaR”) for a single operational risk cell. Their earlier body of work, entitled "Operational VaR: A Closed-form Approximation," demonstrated the ability to derive closed formulas for the calculation of univariate OpVaR at high confidence levels – an enhancement over commonly-used "black-box" simulation approaches to this issue since a closed formula generally allows for better analysis of the end result.

Mr. Böcker and Professor Klüppelberg pursued their research in the context of Basel II’s revised international framework for capital adequacy, which seeks to more closely align banks’ regulatory capital requirements with current and future risks. This revised framework allows for the increased use of internal bank risk assessments and quantification methods that incorporate individual banks’ market risk, credit risk and operational risk.

Consistent with the objectives of its revised framework, Basel II introduced the Advanced Measurement Approaches (AMA) for assessing operational risk. Banks choosing to use an AMA to calculate the regulatory capital charge for operational risk must receive prior approval for a comprehensive operational risk measurement system that incorporates methods, instruments, IT systems, and review, control and monitoring processes.

Basel II explicitly refers to the issue of correlation (or more generally, the dependence structure among different operational risk estimates), which might result in a diversification benefit and an eventual reduction in overall operational risk. In “Multivariate Models for Operational Risk,” Mr. Böcker and Professor Klüppelberg tackled this problem and investigated how such a dependence structure could be modeled using the novel concept of a Lévy copula. By using Lévy copulas, the researchers were able to derive closed-form approximations for important examples of heavy-tailed loss severity distributions and dependence structures.

The Lévy copula draws on the general theory of Lévy stochastic processes, which can be applied to loss distribution concepts employed in the actuarial profession, as well as to operational risk. Use of the Lévy copula in this context is an innovative, intuitive approach with significant benefits for enterprise risk management.

The awarded paper has been widely recognized for its contribution to analyzing the behavior of multivariate operational risk. It has been received very favorably in the regulatory and risk management communities, including Deutsche Bundesbank and delegates to the Risk Capital Conference in Paris in 2006. These and other practitioners are very interested in the fact that closed-formula results for OpVaR can often be applied to estimate OpVaR with a low approximation error.

The co-authors look forward to the prospect of applying their generalized model of multivariate behavior to actual internal bank data for statistical estimations and parameterizing a Lévy copula in practice. They are particularly interested in seeing the Lévy copula becoming more popular in the assessment of operational risk and enterprise risk management in general.

Dr. Dan Oprescu, head of the Risk Management Practice for Financial Architects N.V. (FinArch) and a recognized expert in the field of Enterprise Risk Management, was a member of the selection committee for the PRMIA Institute award. In Dr. Oprescu’s words, the Böcker- Klüppelberg paper stood out among its peers for its theoretical contributions to the analysis of ERM by “proposing a new framework that could unify the modelling of different types of event risk – a very important challenge faced by enterprise-wide risk models today. The paper presents the framework in a mathematically consistent fashion and then investigates some of its likely applications, showing risk modellers and managers how the framework could be adapted to individual circumstances.”

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