FRM Part I · FRM Exam Part I · Operational Risk
In the Loss Distribution Approach (LDA) to operational risk capital, a bank models annual aggregate loss for a business line/event type cell. Which pair of components does the LDA combine to produce the aggregate annual loss distribution?
The LDA combines a frequency distribution for the number of loss events per year with a severity distribution for the size of each loss. Together, typically through simulation, they produce the aggregate annual loss distribution from which operational risk capital is read at a high percentile.
- AA severity distribution for individual loss amounts and a frequency distribution for the number of losses per yearCorrect
- BA probability of default distribution and a loss given default distribution
- CA market factor distribution and a correlation matrix of risk factors
- DA scenario score distribution and a key risk indicator threshold distribution
Explanation
The LDA models how often losses occur (frequency, e.g., Poisson) and how large each loss is (severity, e.g., lognormal), then combines them, usually by Monte Carlo simulation, into an aggregate annual loss distribution. The PD/LGD pair belongs to credit risk modeling.
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