So this is the math that’s wreaked havoc on the global economy.
Wired’s got a great story about David X. Li, the Chinese-born mathematician whose formula (above) was largely responsible for the financial meltdown — or at least the global misuse and abuse of this formula and its dangerous assumptions.
From the piece:
[In 2000,] Li wrote a model that used price rather than real-world default data as a shortcut (making an implicit assumption that financial markets in general, and CDS markets in particular, can price default risk correctly).
It was a brilliant simplification of an intractable problem. And Li didn’t just radically dumb down the difficulty of working out correlations; he decided not to even bother trying to map and calculate all the nearly infinite relationships between the various loans that made up a pool. What happens when the number of pool members increases or when you mix negative correlations with positive ones? Never mind all that, he said. The only thing that matters is the final correlation number—one clean, simple, all-sufficient figure that sums up everything.
You can download Li’s paper, “On Default Correlation: A Copula Function Approach,” here.
Other media outlets have been covering Li too:
CBC: Was David Li the guy who ‘blew up Wall Street?’ (April 9, 2009)
Financial Times: Of couples and copulas (April 24, 2009)
The Wall Street Journal: Slices of Risk: How a Formula Ignited Market that Burned Some Big Investors (September 12, 2005)
So where is Li now?
Reports the CBC:
These days Li, 45, is in China, the country where he was born, keeping a low profile. He heads the risk-management department of China International Capital Corporation in Beijing.
The company won’t make him available for interviews. But according to friends, Li is said to be “sheepish” about all the trouble he has caused.
