September 2014 Q6

[Alibaba]

Regarding the part of this question where you have to calculate the operational risk capital - the exam report says "in the best estimate scenario, neither risk is expected to happen" and so the best estimate cost is zero.

I would have thought that best estimate is equivalent to expected value / mean, and not the median. I feel like this is broadly the consensus on what best estimate means and haven't really come across any situation in work or study where the median is used. Is it fair to say that an approach which gets the capital requirement relative to expected value would have gotten marks? Is there any real life context where the median of the distribution could legitimately be taken as the best estimate?

 

[David Wilmot]

Hi Alibaba,

In the SP9 exam, it is often the case that 'there is no single right answer', and that well-argued answers will be given credit.

In ActEd's ASET for this exam we took a different approach, as follows:

For operational risk, expected losses are:
Risk A: £500,000 x 5% = £25,000
Risk B: £1,000,000 x 0.25% = £2,500
Total expected loss = £27,500

At the 99.5 percentile, risk A is assumed to occur at a cost of £500,000, but risk B does
not (so zero cost).

Hence, VaR(Op) = £500,000 - £27,500 = £472,500

David