Wired Magazine has answered the call in the article Recipe for
Disaster. This article outlines the actual mathematical formula,
a Gaussian copula, upon which so many derivatives are based. In
2000, while working at JPMorgan Chase, Li published a paper in
The Journal of Fixed Income titled "On Default Correlation: A
Copula Function Approach." (In statistics, a copula is used to
couple the behavior of two or more variables.) Using some
relatively simple math—by Wall Street standards, anyway—Li came
up with an ingenious way to model default correlation without
even looking at historical default data. Instead, he used market
data about the prices of instruments known as credit default
swaps. You must read the entire article, yes they mention
mathematics, but they are explaining it all in layman's terms.
One thing I did not know, pointed out in the article, is that
there are no limits on the number of CDS (credit default swaps)
that can be issued against one borrower. CDSes are literally
unconstrained by are subje