http://www.defaultrisk.com/_pd...unction%20Approach.pdf
Wired has an interesting article that places the above publication at the heart of Wall Streets collapse.
"In 2000, while working at JPMorgan Chase, Li published a paper in The Journal of Fixed Income titled "On Default Correlation: A Copula Function Approach." (In statistics, a copula is used to couple the behavior of two or more variables.) Using some relatively simple math?by Wall Street standards, anyway?Li came up with an ingenious way to model default correlation without even looking at historical default data. Instead, he used market data about the prices of instruments known as credit default swaps."
"The effect on the securitization market was electric. Armed with Li's formula, Wall Street's quants saw a new world of possibilities. And the first thing they did was start creating a huge number of brand-new triple-A securities. Using Li's copula approach meant that ratings agencies like Moody's?or anybody wanting to model the risk of a tranche?no longer needed to puzzle over the underlying securities. All they needed was that correlation number, and out would come a rating telling them how safe or risky the tranche was.
As a result, just about anything could be bundled and turned into a triple-A bond?corporate bonds, bank loans, mortgage-backed securities, whatever you liked. The consequent pools were often known as collateralized debt obligations, or CDOs. You could tranche that pool and create a triple-A security even if none of the components were themselves triple-A. You could even take lower-rated tranches of other CDOs, put them in a pool, and tranche them?an instrument known as a CDO-squared, which at that point was so far removed from any actual underlying bond or loan or mortgage that no one really had a clue what it included. But it didn't matter. All you needed was Li's copula function.
The CDS and CDO markets grew together, feeding on each other. At the end of 2001, there was $920 billion in credit default swaps outstanding. By the end of 2007, that number had skyrocketed to more than $62 trillion. The CDO market, which stood at $275 billion in 2000, grew to $4.7 trillion by 2006."
crazy to think that a single individual could have such an incidentally disasterous impact on the entire world yet have a wiki entry that is a single sentence and contains only the two references linked in this post.
the WSJ also published an article titled "How a Formula Ignited Market That Burned Some Big Investors" on 9-12-05 so they deserve some credit.
Wired has an interesting article that places the above publication at the heart of Wall Streets collapse.
"In 2000, while working at JPMorgan Chase, Li published a paper in The Journal of Fixed Income titled "On Default Correlation: A Copula Function Approach." (In statistics, a copula is used to couple the behavior of two or more variables.) Using some relatively simple math?by Wall Street standards, anyway?Li came up with an ingenious way to model default correlation without even looking at historical default data. Instead, he used market data about the prices of instruments known as credit default swaps."
"The effect on the securitization market was electric. Armed with Li's formula, Wall Street's quants saw a new world of possibilities. And the first thing they did was start creating a huge number of brand-new triple-A securities. Using Li's copula approach meant that ratings agencies like Moody's?or anybody wanting to model the risk of a tranche?no longer needed to puzzle over the underlying securities. All they needed was that correlation number, and out would come a rating telling them how safe or risky the tranche was.
As a result, just about anything could be bundled and turned into a triple-A bond?corporate bonds, bank loans, mortgage-backed securities, whatever you liked. The consequent pools were often known as collateralized debt obligations, or CDOs. You could tranche that pool and create a triple-A security even if none of the components were themselves triple-A. You could even take lower-rated tranches of other CDOs, put them in a pool, and tranche them?an instrument known as a CDO-squared, which at that point was so far removed from any actual underlying bond or loan or mortgage that no one really had a clue what it included. But it didn't matter. All you needed was Li's copula function.
The CDS and CDO markets grew together, feeding on each other. At the end of 2001, there was $920 billion in credit default swaps outstanding. By the end of 2007, that number had skyrocketed to more than $62 trillion. The CDO market, which stood at $275 billion in 2000, grew to $4.7 trillion by 2006."
crazy to think that a single individual could have such an incidentally disasterous impact on the entire world yet have a wiki entry that is a single sentence and contains only the two references linked in this post.
the WSJ also published an article titled "How a Formula Ignited Market That Burned Some Big Investors" on 9-12-05 so they deserve some credit.
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