Copulas and Wall Street

March 5, 2009
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Wired Magazine has an article this week on the credit crisis: Recipe for Disaster: The Formula That Killed Wall Street. I mention it here as the first instance I know of where the phrase “Gaussian Copula” has been used in a mainstream-media article. David X Li’s Gaussian Copula function is detailed in a sidebar to the article along with concepts like “survival times”, “distribution functions”, and “correlation parameter”. Surprisingly, the article makes no mention of extreme value theory, but the concept is certainly captured well in this quote:People used the Gaussian copula model to convince themselves they didn’t have any…

Wired Magazine has an article this week on the credit crisis: Recipe for Disaster: The Formula That Killed Wall Street. I mention it here as the first instance I know of where the phrase "Gaussian Copula" has been used in a mainstream-media article. David X Li's Gaussian Copula function is detailed in a sidebar to the article along with concepts like "survival times", "distribution functions", and "correlation parameter". Surprisingly, the article makes no mention of extreme value theory, but the concept is certainly captured well in this quote:

People used the Gaussian copula model to convince themselves they didn't have any risk at all, when in fact they just didn't have any risk 99 percent of the time. The other 1 percent of the time they blew up.

Other articles have made a similar point about stuffing risk into the tails, but this is the first I've seen that describes its statistical underpinnings.