FRM Part I · FRM Exam Part I · Operational Risk

Which statement best describes why extreme value theory (EVT), such as the peaks-over-threshold method with a generalized Pareto distribution, is used in operational risk severity modeling?

EVT is used because operational losses have heavy tails and standard distributions fit the extreme losses poorly. The peaks-over-threshold method fits a generalized Pareto distribution to losses above a high threshold, concentrating on the tail that determines high-percentile capital.

1. AIt models only the tail of losses above a high threshold, where body-fitting distributions often fit poorlyCorrect
2. BIt removes the need to set any threshold in the data
3. CIt guarantees that the aggregate loss distribution is normal
4. DIt models loss frequency using a Poisson process only