The damage was foreseeable and, in fact, foreseen. In 1998, before Li had even invented his copula function, Paul Wilmott wrote that “the correlations between financial quantities are notoriously unstable.” Wilmott, a quantitative-finance consultant and lecturer, argued that no theory should be built on such unpredictable parameters. And he wasn’t alone. During the boom years, everybody could reel off reasons why the Gaussian copula function wasn’t perfect. Li’s approach made no allowance for unpredictability.
From this and other scattered things I’ve read, this sounds like a fatal organizational problem, ascribable to managerial bad judgment culpably motivated by greed and toxic optimism.
The finance people couldn’t understand the math, or refused to, so they ignored the nitpicky warnings from the mathematicians. The quants may not have understood the economic and financial aspects, or maybe they also just didn’t care, since they were having the best paydays of their lives. In any case, there was an enormous pathology at the quant-finance interface.
Everyone involved saw the bonus checks rolling in, and maybe they just decided that the problems with the Gaussian copula formula probably really weren’t very important, because of complexity or emergence or disseminated intelligence or consilience or the cosmic vortex or the Aquarian Age or the singularity or some other reason which they also didn’t understand. Not their department. Nobody’s department.
And then BOOM! Half of everything was gone, and the joke was on us.
I don’t understand a bit of the math, but as it turned out, neither did they. Another joke on us!
I love the Three Stooges.