Mathematician who changed the history. Probably very few people know that we are obliged to the mathematician David X Li and his well-known âLiâs formulaâ based on âGaussian kopula functionâ for the crisis 2008 and its consequences which the world face till now. Kopula is a multidimensional function of distribution defined on a n-dimensional single cube [0, 1] n, and that each of its marginal distribution evenly on an interval [0, 1]. David Li created a formula by means of which with very high percent of probability itâs possible to calculate the casual determined distribution of a variable in a digital row when you are modeling an investment portfolio. In practice the formula showed a brilliant result and all big players of the equity market that had access to this formula began to worship to it as to a golden calf. Now investment institutes ceased to be afraid of mistakes in the calculations and the rivers of securities began to join the huge monetary sea named the bonds provided with debts. Thus the world have seen the boom and euphoria that begun in 2006. It was invested only 270 billion dollars in bonds before emergence of the formula. And in 2006 the total amount of monetary weight that was in the market of debt bonds made 4,7 trillion dollars. Only monetary weight invested in credit default swaps CDS increased from 920 billions to 62 trillion dollars. It was even offered to nominate David Li to the Nobel Prize. And here comes that wasnât considered by Liâs formula. Hundreds of billions dollars that were invested in the real estate start to give failure. Because all those ordinary people which took the credit under real estate were far from Liâs formula and many of them didn't even think that itâs always necessary to pay the credits. Only in this case the formula will work and will make for their owners the inconceivable profit. All credits in the built system have to be extinguished. The result of unaccounted function by Mr. James X Li we will feel for a long time. And till now it is not known how all this will end.
You're a little late to the party. Wired magazine had a great article back in Fed. 09 on just this topic. One of my all time favorites. "Recipe for Disaster: The Formula That Killed Wall Street" http://www.wired.com/techbiz/it/magazine/17-03/wp_quant?currentPage=all
On the same subject, did you know that the now famous BlackâScholes formula for options pricing is flawed and has been designated to favor the options sellers, not the buyers? Bottom line, Wall Street is always creating new "mathematical" tools to legally take more money from Joe Six Pack...
in spite of that, more fortunes are made buying options than selling them. Sellers make all kinds of money then blow up royally at some point.
Don't be silly... The formula is not "flawed". It's a result of a model. Models are not perfect representations of reality, as everyone in the mkts knows. Saying that Black-Scholes is flawed is like saying that Newton's laws of motion are flawed.
I have heard rumors that market maker options sellers tend to last about 7 years or so but I have found nothing firm about where that "nugget" comes from. Why do sellers tend to blow up? (Improper position sizing? Gamma risk? Improper hedging? Ego gets larger than their account? )
What you seem to overlook is the fact that for each million earned buying options, two or three are lost. The amateurs, yes, but the pros always hedge their bets. And that's precisely why they stay in business.