| This is so retarded. Everyone has known for decades that these models (Black Scholes / Gaussian Copula) are wildly inaccurate in the tails. where the real risks live. They are roughly accurate on quiet days. Mandelbrot has been publishing on this since the 1960s! Anyone who pretends to believe these models is running a scam of some kind. It is true that the GC played a minor role in the recent crisis but Black Scholes did not. See below for details. The factors in the 2007-2012 crisis: 1. Fraudulent lending practices and falsified loan applications. 2. Excessive borrowings by households fueled by the Fed keeping interest rates too low for too long. 3. Belief that present trends would continue forever and house prices would continue to the moon. 4. Greed blinded people to the risks they were taking. 5. Lax to nonexistent regulation which allowed banks and related organizations to leverage to insane levels. It also allowed companies like AIG to sell insurance that they could not pay off on. 6. Risks were ignored due to perceived government guarantees (Fannie Mae and her ilk). 7. Fraudulently selling subprime toxic garbage as AAA securities. This is where the Gaussian Copula came in. Given known wrong and bogus assumptions (eg that house prices would never fall across the whole USA), it allowed the investment banks to pretend that the top tiers of the subprime securities were AAA ie secure. Internal emails showed they knew they were not really AAA. However the GC was only the vehicle; the underlying problem was fraudulent and criminal intent. 8. Rating agencies were paid large sums of money to rate the toxic waste as AAA. They either knew or did not care that the securities were toxic waste as long as they got the cash. 9. Pension funds and other naive investors believed that the rating agencies and investment banks were not lying when they said the AAA-rated securities were OK. 10. More recently we have seen the crisis in Europe which is the result of the failure to rein in housing bubbles caused by too-loose credit, and by governments which borrowed more than they could afford to pay back, and which made commitments that they could never fulfill (eg excessive pensions). BS played a role in the near meltdown in 1998 when LTCM went down, and also in the 1987 stock market crash. In both cases idiots pushed the models outside their sphere of validity. LTCM was leveraged to the hilt and assumed that short term historical correlations would continue to prevail. A cursory examination of history would show this is not the case. In 1987 a technique called "portfolio insurance" was invented which supposedly allowed the user to simulate a protective "put option" at no cost. Portfolio insurance required selling stocks when the market fell. The BS model assumes infinite liquidity and no price jumps and if these are true PI should work. Again these are not valid assumptions and when the technique was implemented on the overvalued October 1987 market it accelerated and intensified the crash. Even in physics most models are inaccurate outside a certain range of validity. It requires a degree of honesty and intellectual integrity to refrain from using them when they are not valid. Eg you cannot use Newtonian mechanics at 99.999% of the speed of light. TL;DR this was not a mathematical mistake - it was fraud. |