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David X. Li (born in China in the 1960s as Xiang Lin Liis a quantitative analyst and a qualified actuary who in the early 2000s pioneered the use of Gaussian copula models for the pricing of collateralized debt obligations (CDOs).The Financial Times called him "the world’s most influential actuary," while in the aftermath of the Global financial crisis of 2008–2009, to which Li's model has been credited partly to blame, his model has been called a "recipe for disaster".
Biography
Li was born as Xiang Lin Li and raised in a rural part of China during the 1960s; his family had been relocated during the Cultural Revolution to a rural village in southern China for "re-education". Li was talented and with hard work he received a master's degree in economics from Nankai University, one of the country’s most prestigious universities. After leaving China in 1987 at the behest of the Chinese government to learn more about capitalism from the west. he earned an MBA from Laval University in Quebec and a PhD in statistics from the University of Waterloo in Ontario. At this point he changed his name to David X. Li. His financial career began in 1997 at Canadian Imperial Bank of Commerce,and by 2003 he was director and global head of derivatives research at Citigroup. In 2004 he moved to Barclays Capital and headed up the quantitative analytics team.In 2008 Li moved to Beijing where he works for China International Capital Corporation as head of the risk management department.
CDOs and Gaussian copula
Li's paper "On Default Correlation: A Copula Function Approach"(2000) was the first appearance of the Gaussian copula applied to CDOs, which quickly became a tool for financial institutions to correlate associations between multiple securities. This allowed for CDOs to be accurately priced for a wide range of investments that were previously too complex to price, such as mortgages. However in the aftermath of the Global financial crisis of 2008–2009 the model has been seen as fundamentally flawed and a "recipe for disaster". According to Nassim Nicholas Taleb, "People got very excited about the Gaussian copula because of its mathematical elegance, but the thing never worked. Co-association between securities is not measurable using correlation"; in other words because past history is not predictive of the future. "Anything that relies on correlation is charlatanism."
Li himself apparently understood the limitation of his model, in 2005 saying "Very few people understand the essence of the model." Li also wrote that "The current copula framework gains its popularity owing to its simplicity....However, there is little theoretical justification of the current framework from financial economics....We essentially have a credit portfolio model without solid credit portfolio theory." Kai Gilkes of CreditSights says "Li can't be blamed", although he invented the model, it was the bankers who misinterpreted and misused it."
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