'The formula that killed Wall Street': The Gaussian copula and modelling practices in investment banking

Research output: Contribution to journalArticlepeer-review

Abstract

Drawing on documentary sources and 114 interviews with market participants, this and a companion article discuss the development and use in finance of the Gaussian copula family of models, which are employed to estimate the probability distribution of losses on a pool of loans or bonds, and which were centrally involved in the credit crisis. This article, which explores how and why the Gaussian copula family developed in the way it did, employs the concept of ‘evaluation culture’, a set of practices, preferences and beliefs concerning how to determine the economic value of financial instruments that is shared by members of multiple organizations. We identify an evaluation culture, dominant within the derivatives departments of investment banks, which we call the ‘culture of no-arbitrage modelling’, and explore its relation to the development of Gaussian copula models. The article suggests that two themes from the science and technology studies literature on models (modelling as ‘impure’ bricolage, and modelling as articulating with heterogeneous objectives and constraints) help elucidate the history of Gaussian copula models in finance.
Original languageEnglish
Pages (from-to)393-417
Number of pages25
JournalSocial Studies of Science
Volume44
Issue number3
Early online date6 Feb 2014
DOIs
Publication statusPublished - 1 Jun 2014

Keywords

  • Gaussian copula
  • financial modelling
  • investment banking
  • finance
  • performativity

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