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J.D. Opdyke - Robust Stats - ABA Presentation - 08-08-11 - Updated Scrib

J.D. Opdyke - Robust Stats - ABA Presentation - 08-08-11 - Updated Scrib

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Published by jdopdyke
ABSTRACT:
In operational risk measurement, severity distribution parameter estimation remains a non-trivial challenge for many reasons. Maximum likelihood estimation (MLE) does not adequately meet this challenge because of its well-documented non-robustness to modest violations of idealized textbook model assumptions (e.g. “i.i.d.,” which OpRisk loss event data clearly violate). Biased parameter estimates, leading to capital estimates that substantially over/understate the true risk profile, are but one possible consequence, and this appears to be especially likely when dealing with data collection thresholds by using truncated distributions. Truncation typically induces dependence between a distribution’s parameters (if not there already), and this exacerbates the non-robustness of MLE. This presentation derives influence functions for MLE under a number of severity distributions, truncated and not, to analytically demonstrate its non-robustness. Simulations and empirical influence functions are then used to empirically compare its statistical properties to those of robust alternatives. These results show that robust statistics unambiguously beat MLE on key statistical criteria (robustness, efficiency, and unbiasedness) and remain a promising alternative to MLE for use in the OpRisk setting.
ABSTRACT:
In operational risk measurement, severity distribution parameter estimation remains a non-trivial challenge for many reasons. Maximum likelihood estimation (MLE) does not adequately meet this challenge because of its well-documented non-robustness to modest violations of idealized textbook model assumptions (e.g. “i.i.d.,” which OpRisk loss event data clearly violate). Biased parameter estimates, leading to capital estimates that substantially over/understate the true risk profile, are but one possible consequence, and this appears to be especially likely when dealing with data collection thresholds by using truncated distributions. Truncation typically induces dependence between a distribution’s parameters (if not there already), and this exacerbates the non-robustness of MLE. This presentation derives influence functions for MLE under a number of severity distributions, truncated and not, to analytically demonstrate its non-robustness. Simulations and empirical influence functions are then used to empirically compare its statistical properties to those of robust alternatives. These results show that robust statistics unambiguously beat MLE on key statistical criteria (robustness, efficiency, and unbiasedness) and remain a promising alternative to MLE for use in the OpRisk setting.

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Published by: jdopdyke on Aug 13, 2011
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 ©J.D. Opdyke
1
Presented at American Bankers Association Operational Risk Modeling Forum,August 10-11, 2011Discussant: BakhodirA. Ergashev, Ph.D.Lead Financial Economist, Federal Reserve Bank of Richmond
Robust Statistics vs. MLE for OpRiskSeverity Distribution Parameter Estimation
*The views presented herein are the views of the sole author, J.D. Opdyke, and do not necessarily reflect the views of other conferenceparticipants or discussants. All derivations, and all calculations and computations, were performed by J.D. Opdykeusing SAS
 ® 
: any errors aremy own.
John Douglas (J.D.) Opdyke*, PresidentDataMineIt, JDOpdyke@DataMineIt.com
 
 ©J.D. Opdyke
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1.The OpRiskSetting and the Specific Estimation Objective2.MLE vs. Robust Statistics: Point-Counterpoint3.OpRiskEmpirical Challenges4.Maximum Likelihood Estimation (MLE)5.Robust Statistics
a.Background and The Influence Function (IF)b.IF Derived for MLE estimators of Severity Distribution Parametersc.Robust Estimators: OBRE and CvM
6.Left Truncation Matters, the Threshold Matters7.Results: IF, EIF, SimulationsNo Truncation, Left Truncation, & “Shifted”Bias, (Relative) Efficiency, Robustness8.CvMand OBRE, Pros and Cons9.Potential Limitations of Robust Statistics Generally10.Point-Counterpoint Revisited: Who Wins?11.New Findings, Summary, Conclusions & Recommendations, Next Steps12.References, Appendices
Contents
 
 ©J.D. Opdyke
3
Operational RiskBasel II/IIIAdvanced Measurement ApproachRisk Measurement & Capital QuantificationLoss Distribution ApproachFrequency DistributionSeverity Distribution*
(arguably the main driver of theaggregate loss distribution)
1. The OpRiskSetting and the Specific Objective
* Dependence between the frequency and serveritydistributions under some circumstances is addressed later in the presentation.** Technically, the term “efficient” can refer to an estimator that achieves the Cramér-Raolower bound. Hereafter in this presentation, the terms“efficient” and “efficiency” are used in a relative sense, as inhaving a lower mean squared error relative to that of another estimator. SeeAppendix I.
Specific Objective:Select / develop a method to estimate the parameters of theseverity distribution based on the following criteria –unbiasedness, (relative) efficiency,** and robustness –with anemphasis on how these affect (right) tail-fit.

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