Tuesday, March 10, 2009

Quants: "They sold their souls to the devil"

I was always a bit suspicious of "quants" and their seeming "mastery" of finance and treatment of markets as a form of math and science, but now an article in The New York Times by Dennis Overbye entitled "They Tried to Outsmart Wall Street" lays bare the naked folly of such a proposition. This is hard-core emperor-without-any-clothes stuff and helps to explain a lot of the bizarre risk-taking that has brought our banking system and economy to its knees. Some choice quotes:

... "All I can say is, beware of geeks bearing formulas," Warren Buffett said ...

... As Dr. Derman put it in his book "My Life as a Quant: Reflections on Physics and Finance," "In physics there may one day be a Theory of Everything; in finance and the social sciences, you're lucky if there is a useable theory of anything." ...

... termed the market "a wild beast" that cannot be controlled ...

... "It's not like building a bridge. If you're right more than half the time you're winning the game."...

... "They sold their souls to the devil,"...

... "I haven't met many quants who said they were in finance because they were in love with finance."...

... his boss was fascinated anyway by the graphical user interface, a novelty on Wall Street at the time. ...

... when you need financial models the most ... they might break down. ...

... a Merrill Lynch memorandum noted that the financial models "may provide a greater sense of security than warranted; therefore reliance on these models should be limited." ...

... Given the state of the world, you might ask whether quants have any idea at all what they are doing. ...

... "What is amazing to me as I learn about this is how flimsy was the theoretical basis of the claims that derivatives and other complex financial instruments reduced risk, when their use in fact brought on instabilities." ...

... "Every trader will tell you that every risk manager is a fraud," ...

... the odds of game-changing outliers like Bill Gates's fortune or a Black Monday are actually much greater than the quant models predict, rendering quants useless or even dangerous ...

... "... physicists should go back to the physics department and leave Wall Street alone," ...

... models ... can be a useful guide to thinking as long as you do not confuse them with real science ...

... "Nobody ever took these models as playing chess with God." ...

... Do some people take the models too seriously? "Not the smart people," ...

... Quants say that they should not be blamed for the actions of traders. ...

... "We did try to warn people," ... "This is a crisis caused by business decisions. ...

... By their activities, quants admit that despite their misgivings they have at least given cover to some of the wilder schemes of their bosses, allowing traders to conduct business in a quasi-scientific language and take risks they did not understand. ...

... Wall Street was not looking for Ph.D.'s, but ... "P.S.D.s -- poor, smart and a deep desire to get rich." ...

And finally, from the caption under a picture of one of these "geniuses":

"Because the math is really complicated people assume it must be right."

That's great, Step One for all of the magic formulas is to assume that human nature does not exist.

Truly appalling.

-- Jack Krupansky

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