The Gaussian copula formula.“The most dangerous part is when people believe everything coming out of it.” Mr. Li, the inventor of the Gaussian copula function.Key explains: “I had a whole lot of people working for me who were at the cutting edge of delivering quite complex and new and innovative products. They tended to either be a new product or into a new market, usually the emerging markets, Russia, Brazil, Argentina. I wasn’t the guy sitting there dreaming it all up, but I was the guy who was responsible for those people.” Did he foresee the problems which resulted in the sub-prime crisis? “Was it hard to predict? Not really.” John Key, 19 July, In search of John Key.
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.