Connectivity and the measurement of operational risk: an input?output approach

Abstract

In this article I propose a framework for the analysis of the interdependencies within a financial institution that is based on the input---output framework originally developed by Leontiev (1941). After discussing the state of the art of operational risk measurement, I briefly review the foundations of input---output analysis and explain how to build an input---output model at the business unit level for a financial institution. I also discuss the suitability of an input---output model in capturing the impact on operational risk losses of the interdependencies within a financial institution and then present, through some numerical examples, how to implement the model within a quantitative framework for the measurement of operational risk. In Ersilia, to establish the relationships that sustain the city's life, the inhabitants stretch strings from the corners of the houses, white or black or gray or black-and-white according to whether they mark a relationship of blood, of trade, authority, agency. When the strings become so numerous that you can no longer pass among them, the inhabitants leave: the houses are dismantled; only the strings and their supports remain. From a mountainside, camping with their household goods, Ersilia's refugees look at the labyrinth of taut strings and poles that rise in the plain. That is the city of Ersilia still, and they are nothing. Italo Calvino, Invisible Cities (1972)