The impact of spillover effects from operational risk events: a model from a portfolio perspective

Abstract

Purpose Financial firms announcing large operational losses have empirically been shown to cause significant negative spillover effects in other non-announcing firms in case of the banking and insurance industry. The purpose of this paper is 1) to model such spillover effects in a network from a portfolio perspective and 2) to holistically assess operational risk, reputational risk and the risk of spillover effects, taking into account the dependencies between these risk types. Design/methodology/approach The authors propose different approaches to model spillover effects with different complexity, including stochasticity and influencing factors within the industry network. They then calibrate the model based on information from previous empirical literature. Findings The results emphasize that spillover effects can represent a considerable (non-diversifiable) risk, especially in portfolios, and that neglecting them may lead to a severe underestimation of the actual impact of single operational loss events. Originality/value This study is relevant not only for a firm’s risk management strategy but also for investors holding a portfolio of firms potentially subject to spillover effects.