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 supposedly 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 history is not predictive of the future, "nything that relies on correlation is charlatanism."
Li himself apparently understood the fallacy 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.
Read more about this topic: David X. Li