FRM Part II · FRM Exam Part II · Risk Measurement and Assessment
In a loss distribution approach (LDA) model for a single operational risk category, a risk analyst assumes that annual loss frequency follows a Poisson distribution with mean 4 and that individual loss severities have an expected value of USD 250,000. Assuming frequency and severity are independent, what is the expected annual aggregate loss?
The expected annual aggregate loss is USD 1,000,000. Under independence of frequency and severity, it equals the expected number of losses (4) multiplied by the expected severity (USD 250,000).
- AUSD 62,500
- BUSD 250,000
- CUSD 1,000,000Correct
- DUSD 1,250,000
Explanation
Expected aggregate loss = E[N] x E[X] = 4 x 250,000 = USD 1,000,000. USD 62,500 divides instead of multiplies. USD 250,000 ignores frequency. USD 1,250,000 adds an extra unit of frequency (5 x 250,000).
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