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The Correlation Problem in Operational Risk

Frachot, Antoine and Roncalli, Thierry and Salomon, Eric (2004): The Correlation Problem in Operational Risk. Published in: Operational Risk (May 2004)

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Abstract

This paper demonstrates that aggregate losses are necessarily low as long as we remain under the standard assumptions of LDA models. Moreover empirical findings show that the correlation between two aggregate losses is typically below 5%, which opens a wide scope for large diversification effects, much larger than those the Basel Committee seems to have in mind. In other words, summing up capital charges is in substantial contradiction with the type of correlation consistent with the standard LDA model.

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