Copulas in the News

Bull Market Copula in Action

I don’t want this blog to become an echo chamber of the same crap they blog about over at Revolutions Blog, but they pointed out a really good article from Wired magazine on the topic of the Gaussian Copula and its roll in the current market meltdown. I was pretty impressed that the author, Felix Salmon was able to boil the issues down well and even give really good examples of how correlations can change over time. He also presented one of the best illustrations of conditional probability by using an example of two school kids. If I keep reading articles like this maybe I will learn to describe what I do for a living better. As it stands I just tell folks at cocktail parties that I play piano in a whorehouse. It’s much easier for them to understand and also more socially acceptable.

One of my favorite lines from the article was the following:

...CDOs were invariably sold on the premise that correlation was more of a constant than a variable.

And I am glad to see Taleb getting more publicity even if it is for salacious sound bites like:

Anything that relies on correlation is charlatanism.

That’s a bit overstating it. But the qualifiers need to make that statement correct are just a bit too long for good publishing.

The article is simultaneously about the Gaussian Copula and also David X. Li who derived the formula for using the Gaussian Copula in bond pricing. His original published article on the topic is still available from Credit Metrics on their web site. I’ve never read the article so I printed it out to read on my flight today. The Wired article does a good job of separating Mr. Li’s derivation of a formula from the true problem, which was the application of this formula. Some stupid idiots who have opined on the topic can’t make that distinction and end up saying fantastically moronic things such as:

So now here we stand. The world's most dynamic economic engine brought to it's knees by one guy.

That’s a bit like blaming the Wright Brothers for the September 11 terrorist attacks. I mean if they had never invented the plane then that attack clearly would not have happened!

At the bottom of the above article I noticed that Mr. Salmon blogs over at Portfolio.com, the web site for Conde Nast(y) Portfolio magazine. I clearly need to start reading Portfolio magazine as that was the same magazine where Michael Lewis’ now infamous article on the death of Wall Street was published. You remember that article, right? It had this fantistic photoshopped image of the Wall Street Bull post copula:

[caption id=“attachment_189” align=“alignleft” width=“300” caption=“Time for a smoke”]Time for a smoke [/caption]

Ahhh. that’s art!

 
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