The Gaussian Copula Model

Created by Dr. David X. Li, this algorithm expresses the degree of variance in risk probability between two given assets as a simple ratio.

Gaussian Copula plot

Put simply, the model enabled packaging of credit default swaps (CDS's) and collateralized debt obligations (CDO's) into securities that could be sold to investors. As this Wired piece by Felix Salmon explains, the quantity of the securities created based on collaterilization outstripped the actual collateral. A simple way of thinking about it is to imagine selling multiple life insurance instruments against an accidental casualty, then experiencing a massive number of casualties. It's both clearer and more insightful than most reporting on the topic. Critics of Gaussian over-exuberance include Darrell Duffie at Stanford.

Here's the article

David X. Li, Ph.D.

Simon, who writes market movers for CondeNast's Portfolio, has an email address at felixATfelixsalmon.com

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