This Wired article is about the world of finance, a famous mathematical formula that created (and lost) trillions of dollars of wealth, and that in the end was an over-simplification of reality and in addition was confused with the real world by people who don’t understand mathematics but are addicted to money. But while the article suggests that the problem was that bankers and investors deluded themselves in thinking they could model just a few years’ worth of data and come up with probabilities for things that may happen only once every 10,000 years, I think it overlooks the real motive behind the market collapse: GREED.
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.
A year ago, it was hardly unthinkable that a math wizard like David X. Li might someday earn a Nobel Prize. After all, financial economists—even Wall Street quants—have received the Nobel in economics before, and Li’s work on measuring risk has had more impact, more quickly, than previous Nobel Prize-winning contributions to the field. Today, though, as dazed bankers, politicians, regulators, and investors survey the wreckage of the biggest financial meltdown since the Great Depression, Li is probably thankful he still has a job in finance at all. Not that his achievement should be dismissed. He took a notoriously tough nut—determining correlation, or how seemingly disparate events are related—and cracked it wide open with a simple and elegant mathematical formula, one that would become ubiquitous in finance worldwide.
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.