An operational risk analyst is attempting to analyze a bank's loss severity distribution. However, historical data on operational risk losses are limited. Which of the following is the best way to address this issue?
A. Generate additional data using Monte Carlo simulation and merge it with the bank's operational losses.
B. Estimate the parameters of a Poisson distribution to model the loss severity of operational losses.
C. Estimate relevant probabilities using expected loss information that is published by credit rating agencies.
D. Merge external data from other banks with the bank's internal data after making appropriate scale adjustments.
Answer:D
For the loss severity distribution, regulators encourage banks to use their own data in conjunction with external data. There are two sources of external data. The first is data obtained through sharing arrangements between banks. (The ìnsurance industry has had mechanisms for sharing loss data for many years and banks are now beginning to do this as well.) The second is publicly available data that have been collected in a systematic way by data vendors. Both internal and external historical data must be adjusted for inflation. In addition, a scale adjustment should be made to external data. So merge external data from other banks with the bank's internal data after making appropriate scale adjustments is an effective way when historical data is lost.

 
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