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AIM 7: Discuss the role severity distributions play in the determination of loss as well as the practical implementation of these distributions.

 

1、Which of the following is not a practical consideration in modeling severity distributions in the loss distribution approach (LDA)?

A) Placing too much emphasis on determining the appropriate capital reserve and not on the possibility of severe losses.
 
B) Extrapolating the data beyond those observed in the internal and external data set.
 
C) Explaining the model to colleagues in other departments.
 
D) Obtaining and calibrating external data.

nayizhenfeng

The correct answer is A

A practical consideration is to recognize that the analyst’s ultimate goal is to determine the operational risk capital reserve, and extrapolations could lead to the inclusion of extremely severe losses and an overestimation of the needed capital reserve.

nayizhenfeng

AIM 8: Explain the process of building a piece-wise defined distribution.

 

1、With respect to the loss distribution approach (LDA), which of the following best characterizes a methodology for building an adequate representation in the tail? Establish a threshold representing an absolute value of losses and then:

A) use only internal data for losses less than the threshold and both internal and external data for losses greater than the threshold.
 
B) use only internal data for losses greater than the threshold and both internal and external data for losses less than the threshold.
 
C) use only internal data for losses less than the threshold and only internal data for losses greater than the threshold but with a higher weight on the latter.
 
D) use only internal data for losses less than the threshold and only internal data for losses greater than the threshold but with a higher weight on the former.

nayizhenfeng

The correct answer is A

To build a model of a distribution that includes adequate representation in the tail, an analyst may wish to piece together the distribution in the following way:

1、For a given cell, model the distribution only using internal data for that cell that are below a given threshold.
2、For the same cell, model the distribution using both internal and external data that fall beyond the threshold.

nayizhenfeng

AIM 10: Discuss various types of dependencies in the model and how to model correlation.

 

1、In the loss distribution approach (LDA), which of the following within cell dependencies or correlations can affect the probability of loss and the economic capital of the bank? The dependencies between:

severity samples in a cell.
occurrence of loss events.
the frequency distribution and the severity distribution.
A) I, II, and III.
 
B) II and III only.
 
C) I and II only.
 
D) None of these.

nayizhenfeng

The correct answer is A

There can be within cell dependencies which include the dependence between the occurrence of loss events, the frequency distribution and the severity distribution, severity samples in a cell.

nayizhenfeng

AIM 11: Discuss the relationship between loss distribution approach and insurance.

 

1、With respect to including the role of insurance in the loss distribution, the analyst would:

A) allow for the risk reducing effect of insurance, generally, by reducing the frequency of losses but not their severity.
 
B) allow for the risk reducing effect of insurance, generally, by reducing the severity of losses that exceed a given deductible but not adjusting the frequency.
 
C) allow for the risk reducing effect of insurance, generally, by reducing both the frequency and severity of losses.
 
D) ignore it because the point is to model the losses regardless of insurance.

nayizhenfeng

The correct answer is B

The loss distribution approach allows for a risk profiling of an institution, which can include the risk reducing effect of insurance. Insurance alters the aggregate loss distribution. Typically this is done by reducing the severity of the losses that exceed a given deductible in the insurance policy. In other words, insurance typically lowers the severity but not the frequency.

nayizhenfeng

AIM 12: Explain the approach followed in determining economic capital, including allocation techniques and Monte Carlo methods.

 

1、The standard procedure for credit and operational risk is to specify the Economic Capital as:

A) Value-at-Risk divided by Expected Loss.
 
B) Value-at-Risk minus Expected Loss.
 
C) Value-at-Risk plus Expected Loss.
 
D) Value-at-Risk.

nayizhenfeng

The correct answer is B

VaR is widely used in this context. In credit risk, Expected Loss denotes the mean of the portfolio loss distribution.