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Answer: Loss severity and loss frequency are often modeled with lognormal and Poisson distributions, respectively.
## Explanation **B is correct** because: - 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 tends to be modeled with a lognormal distribution, which captures the right-skewed nature of operational loss amounts **A is incorrect** because economic capital covers the difference between the worst-case loss and the expected loss, not both. Expected losses are typically covered by provisions or pricing, while economic capital is reserved for unexpected losses. **C is incorrect** because operational loss data from vendors tends to be biased toward large losses (due to reporting thresholds and media coverage), and this data is most useful for determining relative loss severity rather than loss frequency. **D is incorrect** because under the standardized approach for operational risk capital calculation, banks apply a fixed percentage to gross income of each business line. The standardized approach does not require banks to estimate unexpected losses separately.
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The CRO of a large bank is interviewing a candidate for an operational risk analyst position. The CRO asks the candidate several questions about various aspects of operational risk measurement. Which of the following responses given by the candidate is correct?
A
Economic capital of a bank should be sufficient to cover both the expected and the worst-case operational risk losses of the bank.
B
Loss severity and loss frequency are often modeled with lognormal and Poisson distributions, respectively.
C
Operational loss data available from data vendors tend to be biased toward small losses but are particularly useful in determining loss frequency.
D
The standardized approach used by banks in calculating operational risk capital requires the calculation of unexpected as well as expected losses.