Extremes in operational risk management

Operational risk is defined as a consequence of critical contingencies most of which are quantitative in nature and many questions regarding economic capital allocation for operational risk continue to be open. Existing quantitative models that compute the value at risk for market and credit risk do not take into account operational risk. They also make various assumptions about ’normality’ and so exclude extreme and rare events. In this paper we formalize the definition of operational risk and apply extreme value theory for the purpose of calculating the economic capital requirement against unexpected operational losses.