Money Mondays

The formula that killed Wall Street

Mathematician David 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.

I've read this article several times but I still don't understand it (see link below). It's a refreshing take on what went wrong regarding the financial markets and economic meltdown but I still don't get it. It is refreshing in that, it describes the whole phenomena from a mathematical perspective not just speculation which is what the other articles written by normal people tried to do. In a nutshell, a Chinese guy by the name of David X. Li, came up with a formula that could predict risk and uncertainty in financial markets specifically for complicated instruments known as Credit Default Swaps. However, the formula wasn't tested properly due to the limited availability of historical data. So its applicability and robustness wasn't properly determined.

But since the money managers were making a lot of money from the newly created instruments - nobody bothered questioning the knowledge. In actuality this goes to show that no one knows anything anymore, and no one is brave enough to ask the stupid and simple questions which reveal the truth. Nassim Nicholas Taleb, hedge fund manager and author of The Black Swan, is particularly harsh when it comes to David Li's formula. "People got very excited about the Gaussian copula because of its mathematical elegance, but the thing never worked," he says. Even David Li, himself warned people of his formula stating: "The most dangerous part is when people believe everything coming out of it."

For me what this says, is this, do not put your money in things that you don't understand because some guy with an MBA tells you it will make you a lot of money. If it's too good to be true, there's something wrong there. RUN. The whole world was fooled by this nonsense and these are the people that we trust with our hard-earned cash to invest it for us. Bollocks, man!

(via portfolio.com: http://www.portfolio.com/business-news/2009/03/03/Formula-That-Killed-Wall-Street)