Market Data vs. Real Data

The story about the formula that killed Wall Street illustrates the extreme importance of obtaining real-world first-hand data. It is the availability of CDS market data that makes the correlation between default risks quantitatively measurable using the Gaussian copula model in spite of the scarcity of real historical default data, and thus enables the invention and proliferation of CDOs. However, it is also because that the model is based on the CDS market data rather than the real historical default data, applying it without prudence can lead to catastrophic outcomes as witnessed by the recent global financial crisis. The key to his success is also his undoing. When there are no sufficient data, the so-called wisdom of the crowd is not reliable at all.