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The Formula That Killed Wall Street
We recently discussed the perspective that the harrowing of Wall Street was caused by over-reliance on computer models that produced a single number to characterize risk. Wired has a piece profiling David X. Li, the quant behind the formula that enabled the creation of such simple risk models. "For five years, Li's formula, known as a Gaussian copula function, looked like an unambiguously positive breakthrough, a piece of financial technology that allowed hugely complex risks to be modeled with more ease and accuracy than ever before. With his brilliant spark of mathematical legerdemain, Li made it possible for traders to sell vast quantities of new securities, expanding financial markets to unimaginable levels. His method was adopted by everybody from bond investors and Wall Street banks to ratings agencies and regulators. ... [T]he 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."
Your first surmise was probably correct. :-)
Shhhhh! Or they'll start quoting Ayn Rand if you anger them. And no one wants the rugged individualists to proclaim their slavish devotion to a hack, now do we? ;)
However, if the model shows tempatures are warming. Then the model is accurate. Because that is the consensus and the model is only confirming it. ;-)
Now we see the violence inherent in the system.