Hey, bet you don't what a Gaussian copula function is.
It's a Recipe for Disaster and the Formula that Killed Wall Street
Li's Gaussian copula formula will go down in history as instrumental in causing the unfathomable losses that brought the world financial system to its knees.
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Investors exploited it as a quick -and fatally flawed- way to assess risk.
David Li incidentally is a star mathematician who grew up in rural China in the 1960s. Ah, the irony.
No one knew all of this better than David X. Li: "Very few people understand the essence of the model," he told The Wall Street Journal way back in fall 2005.
"Li can't be blamed," says Gilkes of CreditSights. After all, he just invented the model. Instead, we should blame the bankers who misinterpreted it. And even then, the real danger was created not because any given trader adopted it but because every trader did. In financial markets, everybody doing the same thing is the classic recipe for a bubble and inevitable bust.
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Nassim Nicholas Taleb, hedge fund manager and author of The Black Swan, is particularly harsh when it comes to the copula. "People got very excited about the Gaussian copula because of its mathematical elegance, but the thing never worked," he says. "Co-association between securities is not measurable using correlation," because past history can never prepare you for that one day when everything goes south. "Anything that relies on correlation is charlatanism."