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FRM Part II · FRM Exam Part II · Risk Measurement and Assessment

A bank's operational risk team is building an internal loss event database. Which of the following is the most appropriate rule for setting the data collection threshold?

The threshold should be set so that it does not exclude losses relevant to tail and frequency estimation, while keeping collection costs sensible, and the choice should be documented. A threshold set too high discards information, and one chosen after seeing the loss introduces bias.

  1. ASet the threshold high enough that only the largest few events are recorded, to keep the database small
  2. BSet the threshold so that it does not omit losses material to the tail, while keeping collection cost reasonable, and document the rationaleCorrect
  3. CSet different thresholds for each loss event, chosen after the loss is known, to reflect management's view of materiality
  4. DSet the threshold at zero for external data only, since internal data are never subject to thresholds

Explanation

A collection threshold should balance cost against completeness: it must not exclude losses that matter for the severity tail, and the rationale should be documented. A very high threshold loses information about frequency and body of the distribution. Setting thresholds after the fact introduces bias.

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