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Infinite-mean Models and the LDA for Operational Risk

by Johanna Nešlehová of RiskLab, ETH Zurich,
Paul Embrechts of ETH Zurich, and
Valérie Chavez-Demoulin of ETH Zurich

Spring 2006

Abstract: Due to published statistical analyses of operational risk data, methodological approaches to the "advanced measurement approach" modeling of operational risk can be discussed in more detail. In this paper we raise some issues concerning correlation (or diversification) effects, the use of extreme value theory and the overall quantitative risk management consequences of extremely heavy-tailed data. We especially highlight issues around infinite-mean models. In addition to methodological examples and simulation studies, the paper contains indications for further research.

Keywords: AMA, coherence, diversification, extremes, infinite mean models, LDA, operational risk, Pareto, subadditivity.

Published in: Journal of Operational Risk, Vol. 1, No. 1, (Spring 2006), pp. 3-25.

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