Operational Risk – Definition

Cite this article as:"Operational Risk – Definition," in The Business Professor, updated March 28, 2019, last accessed October 22, 2020, https://thebusinessprofessor.com/lesson/operational-risk-definition/.

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Operational Risk Definition

Operational risk is the risk a company faces as a result of their operations (the functional aspects of delivering their value proposition). Think of the risk associated with company processes, systems, equipment, or employees. It can be compared to the risk associated with the market or the financial structure.

A Little More on What is Operational Risk

Operational risk focuses on how value is being delivered or how operations are being carried out. It focuses on the possibility of interruptions or failures.  What tasks are being carried out. What are the risks to interruption. It includes risks from human error or oversight. The extent to which human error is applicable will vary between industries.

Areas in which you could observe operational risk are in equipment durability and maintenance, human decision-making, communication processes.

References for Operational Risk

Academic Research on Operational Risk

The invention of operational risk, Power, M. (2005). Review of International Political Economy, 12(4), 577-599. This paper probe into fast evolvement of operational risk commencing from low epistemic status to his climax as a major factor of global banking regulation. Pressure in 3 keys domain of policy controversy was addressed in this research.

Inventory management optimization as part of operational risk management, Michalski, G. (2009). This paper showcase the effects for recipient’s firm that may occur from operational risk that is related to delivery risk that is generated by suppliers. Also it also offers system to deploy to choose supplier.

Quantitative models for operational risk: extremes, dependence and aggregation, Chavez-Demoulin, V., Embrechts, P., & Nešlehová, J. (2006). Journal of Banking & Finance, 30(10), 2635-2658.This research paper look into proffering a strategy that will be useful in any quantitative modelling environment.

Loss distribution approach for operational risk, Frachot, A., Georges, P., & Roncalli, T. (2001). This paper set to review two major scope, the first phase looked into detailed description of LDA enactment and how it is applicable in economic capital allocation. While the second phase a comparative study was done between LDA and internal measurement approach (IMA) which was proposed by Basel committee on Banking supervision to calculate regulatory capital for operational risk.

Infinite mean models and the LDA for operational risk, Nešlehová, J., Embrechts, P., & Chavez-Demoulin, V. (2006). Journal of Operational Risk, 1(1), 3-25. In this journal there was probing into issues concerning correlation (or diversification) effects, the use of extreme value theory and the overall quantitative risk management consequences of extremely heavy-tailed data.

Mandatory disclosure and operational risk: Evidence from hedge fund registration, Brown, S., Goetzmann, W., Liang, B., & Schwarz, C. (2008). The journal of finance, 63(6), 2785-2815. This researched demonstrated that regulators should give report for endogenous production of information and the marginal benefit of disclosure to different investment clienteles.

Implications of alternative operational risk modeling techniques, De Fontnouvelle, P., Rosengren, E., & Jordan, J. (2007). In The Risks of Financial Institutions (pp. 475-512). University of Chicago Press. Researched was done to ascertain empirical regularities in operational loss data.

Statistical models for operational risk management, Cornalba, C., & Giudici, P. (2004). Physica A: Statistical Mechanics and its applications, 338(1-2), 166-172. This paper stated likely options to handle unexpected loss owing to operational risk.

The modelling of operational risk: experience with the analysis of the data collected by the Basel Committee, Moscadelli, M. (2004). This researched focus on, to compare the sensitivity of conventional actuarial distributions and models stemming from the Extreme Value Theory in representing the highest percentiles of the data sets

Operational risk and reputation in the financial industry, Gillet, R., Hübner, G., & Plunus, S. (2010). Journal of Banking & Finance, 34(1), 224-235. After a serial survey on stock market reactions to pronouncement of operational losses by financial firms, this academic review aims to differentiate between operational losses and reputational damage.

Risk mapping and key risk indicators in operational risk management, Scandizzo, S. (2005). Economic Notes, 34(2), 231-256. This academic piece seek to explain the approach for mapping Operational risk with the aim of identifying the risk underlying the different steps of a business process, selecting a set of variables providing an estimate for the likelihood and the severity of operational risk (Key Risk Indicators – KRIs) and designing the most appropriate control activities.

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