FRM Glossary · Part II · Operational Risk

Loss Distribution Approach (LDA)

A bottom-up operational-risk model that convolves severity and frequency distributions into an aggregate loss distribution.

In more detail

Frequency is modelled with a Poisson or negative binomial distribution; severity with a lognormal, gamma, or GPD. Monte Carlo convolves them to produce an annual loss distribution; capital is set to a high quantile (e.g. 99.9%). LDA underpins many banks' AMA submissions and economic capital for op risk.