Functional correlation approach to operational risk in banking organizations

A Value-at-Risk-based model is proposed to compute the adequate equity capital necessary to cover potential losses due to operational risks, such as human and system process failures, in banking organizations. Exploring the analogy to a lattice gas model from physics, correlations between sequential failures are modeled by as functionally defined, heterogeneous couplings between mutually supportive processes. In contrast to traditional risk models for market and credit risk, where correlations are described as equal-time-correlations by a covariance matrix, the dynamics of the model shows collective phenomena such as bursts and avalanches of process failures. (C) 2002 Elsevier Science B.V. All rights reserved.