Explanation

Correct Answer: B

Let's analyze each option:

Option A: Incorrect - Economic capital covers the difference between the worst-case loss and the expected loss, not both the expected and worst-case losses. Expected losses are typically covered by provisions and reserves, while economic capital covers unexpected losses.

Option B: Correct - This statement is accurate:

• Loss frequency is typically modeled using a Poisson distribution, which is appropriate for counting the number of loss events over a given time period.
• Loss severity is often modeled using a lognormal distribution, which is suitable for modeling positive-valued loss amounts that tend to be right-skewed.

Option C: Incorrect - Operational loss data from vendors tends to be biased toward large losses (not small losses) because small losses are often not reported or recorded. These data are most useful for determining relative loss severity, not loss frequency.

Option D: Incorrect - The standardized approach for operational risk capital calculation does not require banks to estimate unexpected losses. Instead, it uses predetermined beta factors applied to gross income across different business lines.

Key Points:

• Economic capital = Unexpected losses = Worst-case loss - Expected loss
• Expected losses are covered by provisions
• Standardized approach uses beta factors based on business lines
• External loss data is biased toward large, publicly reported losses