Interesting article in the Science section of today’s NYTimes: They Tried to Outsmart Wall Street.

“Quants occupy a revealing niche in modern capitalism. They make a lot of money but not as much as the traders who tease them and treat them like geeks. Until recently they rarely made partner at places like Goldman Sachs. In some quarters they get blamed for the current breakdown — “All I can say is, beware of geeks bearing formulas,” Warren Buffett said on “The Charlie Rose Show” last fall. Even the quants tend to agree that what they do is not quite science…

Asked to compare her work to physics, one quant, who requested anonymity because her company had not given her permission to talk to reporters, termed the market “a wild beast” that cannot be controlled, and then added: “It’s not like building a bridge. If you’re right more than half the time you’re winning the game.” There are a thousand physicists on Wall Street, she estimated, and many, she said, talk nostalgically about science. “They sold their souls to the devil,” she said, adding, “I haven’t met many quants who said they were in finance because they were in love with finance.”

Fascinating stuff.

I can recommend the first 3 books, and have the next 2 on my list to read:

  1. The Black Swan: The Impact of the Highly Improbable
    by Nassim Nicholas Taleb (Random House, 2007)
  2. When Genius Failed: The Rise and Fall of Long-Term Capital Management
    by Roger Lowenstein (Random House, 2000)
  3. Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives
    by Satyajit Das (FT Press, 2006)
  4. My Life as a Quant: Reflections on Physics and Finance
    by Emanuel Derman (John Wiley & Sons, 2004)
  5. Physicists on Wall Street and Other Essays on Science and Society (Title Essay)
    by Jeremy Bernstein (Springer, 2008)

>

Source:
They Tried to Outsmart Wall Street
DENNIS OVERBYE
NYT, March 10, 2009

http://www.nytimes.com/2009/03/10/science/10quant.html

Category: Markets

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

44 Responses to “Math & Physics versus Wall Street”

  1. VennData says:

    Michael Lewis should a piece on the quants using the same set formula from Moneyball, with the first chapter a proof of a stochastic process titled “Determining Which Inning We’re In.”

  2. Does anyone really believe Citibank has made 8 billion dollars so far this year?

  3. leftback says:

    “Does anyone really believe Citibank has made 8 billion dollars so far this year?”

    I think they may be counting the $25B we taxpayers shoveled in there as “earnings”, Calvin….?

    Leftback notes that the “Leftback Bottom” (intra-day low of SPX 666.79 on Friday) which we called in real time here at TBP at about 3.45pm was not breached, despite yesterday’s close to the downside. As AT has pointed out, a bear market rally was long overdue so we were not surprised to see this morning’s break to the up side. We continue to believe that the Q1 low is now in, and that we will see a rally of reasonable size. We continue to be long of energy and short of gold*.

    (*that was a Gartmanism, there)

  4. karen says:

    I think it’s a good week to be short gold with all the Treasury offerings coming on line this week.

  5. CNBC Sucks says:

    Fractals schmractals.

    The Dow is up 228, and Bob Pisani has that little hop in his step again. Mark Haines just called the beginning of a 10 – 15% rally. Betcha Taleb and Mandelbrot (what kind of American names are those anyway?) didn’t predict the recession would be over today.

  6. leftback says:

    European Central Banks are to announce gold sales this week. It makes sense here, when else are they going to use it? When the Martians land? Probably a good time to stay out of the water.

  7. leftback says:

    Interesting action today. Panic buying, anyone?? Good day for those long FAS. (Nice trade, Karen!!)

  8. Mannwich says:

    I guess Pandit sees no risking outright lying about the financial condition of his firm. After all, everyone else does it and nobody gets prosecuted. What a country……

  9. HCF says:

    I’ll believe the $8.3B operating earnings for the first two months the same as I believe O.J. is actively searching for the “real killers.”

    HCF

  10. Mannwich says:

    I will be buying FAZ again soon. Just waiting a bit here.

  11. Mannwich says:

    @HCF: “If the glove don’t fit, you must acquit.”

  12. batmando says:

    “Good day for those long FAS. (Nice trade, Karen!!)”
    Believe Karen also picked up AA at the same time, doing even mo’ bettah (up 23%)!

  13. karen says:

    No, it was LB buying AA, i believe… i was buying my 2 shippers dht/pgrn, uco, fas, ibn, uco, fxi, and even some sso. my best price on fas was 2.39 but i was prepared to go to 1. : )

  14. HCF says:

    >i was buying my 2 shippers dht/pgrn, uco, fas, ibn, uco, fxi, and even some sso.

    So is it karen the optimistic trader or karen the cynical trader?

    I guess we were due for a rally (i had dumped most of my SKF but held onto a few shares, oh well. Unfortunately, I’ve been stubbornly holding my FXP and EEV, doh!). Personally, I think this dead cat had it’s belly rubberized and has some explosives tied to its ass, so I have no idea of the magnitude of this bounce before it plummets back to earth =)

    HCF

  15. equity_guy says:

    Barry- I would add Demon of Our Own Design by Richard Bookstaber to your list.

  16. leftback says:

    “So is it karen the optimistic trader or karen the cynical trader?”

    Can’t speak for Karen, but cynicism has served us extremely well at Schadenfreude Asset Management of late.

  17. karen says:

    HCF, always the cynical trader I am. Anyway, it’s what Andy said yesterday: At some point the stocks are themselves Put Options and therefore there is no need to buy protection. Afterall, stocks do stop at ZERO.

  18. HCF says:

    > cynicism has served us extremely well at Schadenfreude Asset Management of late.

    It would serve me better to be more cynical in my behavior (my attitude is plenty cynical already!). I believe I am the Founder, President, CEO, and janitor of STMM (Short Term Masochism Management).

    HCF

  19. joseph.price says:

    As a physicist who used to work in a US investment bank (until it went bankrupt in spectacular style), my view is that the tools of physics are very poorly suited to the world of finance. I am largely in agreement with Soros theory of reflexivity which argues that the physical world and the social world (which includes economics) are fundamentally different. The social world exhibits self-referentiality – ie knowledge of the “laws of economics” changes the law of economics because the new laws of economics now incorporates the new understanding and so behaviour changes.

    I believe that quantitative finance/neoclassical economics as we have seen it over the past few decades has much more to do with ideology than reality. An attempt has been made place economics on the same theoretical footing as the physical sciences, to argue that the laws of economics are invariant and eternal. This is just not true, economic changes society which in turn changes economics. To say that economics is fixed is to say that society is fixed – this is political conservatism at its most raw.

    Fortunately for us all the deeply unjust, highly exploitative and socially/environmentally unsustainable status quo is very rapidly coming to an end. A new society and a new economics are going to be created. This will be better for all of us.

    After the long dark night, finally it is morning in America

  20. Andy Tabbo says:

    Nice hops today. In re: the geeks and the algorithms…I’ve always been skeptical of the blackboxes ability to outperform markets over the long run. When some of these funds like Renaissance were putting up those stellar returns, several people pointed out that it was merely the “leverage” employed that generated the outperformance. It was not “alpha”…it was just “beta” on roids.

    Also, in regard to computer driven models….it can’t “feel” the sentiment extremes. A computer doesn’t know what to make of Erin Burnett riding the Bull outside of the NYSE in the Summer of 2007 or reporting the Iceland and Middle East “miracles” at their peaks. And now in the despair and gloom, it wouldn’t know what to make of Brian Williams doing “Meltdown” specials or the Daily Show doing brutal takedowns of the CNBC crew.

    Short term market….

    I can “see” a small inverted head and shoulder pattern on S&P500 (30 min charts). The minimum target for this pattern is 723, which would match the intraday highs from 3/4/09. It’s interesting to note that the grains look to be breaking out of downtrends with todays action. It’s also interesting to note the clear rounded bottom look to the Euro and Swissy charts. It’s also interesting to observe the break of 900 on gold today…minimum downside is 879, but a more likely target for gold is 838 for an a=c down.

    Are we seeing the beginnings of a really big move up in beaten down asset classes?

  21. wally says:

    “If you’re right more than half the time you’re winning the game.”

    If you’re right more than half the time, you are in the one-half of all people who got one more lucky guess correct than the other half of all people.

  22. CNBC Sucks says:

    joseph.price wrote: “Fortunately for us all the deeply unjust, highly exploitative and socially/environmentally unsustainable status quo is very rapidly coming to an end. A new society and a new economics are going to be created.”

    I hope you are right. Unfortunately, a good 40% of Americans who would benefit from such change oppose that change. It will not take more than a few voters in Ohio, Florida, Colorado, Virginia, North Carolina, and Indiana to once again vote against their economic interests to bring your “new society” to a screeching halt.

  23. Does anyone really believe Citibank has made 8 billion dollars so far this year?

    In bonuses? Yes!

  24. leftback says:

    AT said: “It’s also interesting to note the clear rounded bottom look to the Euro and Swissy charts. It’s also interesting to observe the break of 900 on gold today…minimum downside is 879″

    Gartman and others have been looking at EUR:JPY for a few weeks as a predictor of equity movements. Looking at the US$ build a double top yielded the same conclusions regarding an inevitable rally. Not to say that we will not see another shoulder due to deleveraging in the future before the inevitable $ decline. The GDX is being hammered today, might be some bargains in there before too long.

  25. Kyle says:

    joseph.price

    nice post.

  26. AlexInNC says:

    “After the long dark night, finally it is morning in America”

    I’d hesitate to say that the dawn has finally broken. Not until we have a full understanding of toxic assets on the banks books, a standardized CDS market that is transparent, a full accounting of where TARP et al assets have been used and a clear plan to move forward (anybody catch SNL’s sendup of Geithner on Saturday?) will we be able to see some light.

    With all of these still outstanding, the market is still stumbling from one light post to another, trading on emotions (very strong recency affect) instead of fundamentals.

  27. joseph.price says:

    AlexInNC:

    “After the long dark night, finally it is morning in America” was a rhetorical reference to the Regan era.

    The truth is that the new epoch will not begin until no one gives a damn what the financial markets are upto.

    CDS, TARP, TAFL are the acronymns of a dying age

    Freedom begins when the S&P hits 0

  28. Outlier says:

    If anyone wants to get DEEP into the details of the relationship between economics and physics, Philip Mirowoski’s _More Heat Than Light_ is a pretty incredible journey through the history of the relationship. And no the economics profession does not come out looking particularly credible…

  29. dead hobo says:

    BR wants to read:

    Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives
    by Satyajit Das (FT Press, 2006)

    comment:

    I read this book about a year ago. At the time I understood little about derivatives so I didn’t understand some of the more technical references. Even so, I thought a lot of the book and think I will read it again now that I will understand it better. Thanks for the reminder.

    This may have been the book where I read the phrase that Wall Street is just one big compensation scheme.

    This is a book more about selling derivatives and the derivatives business than a book on finance. There are lots of short stories that describe sales tactics, idiot buyers, and more.

    Highly recommended.

  30. much along the line of AT’s point, above, I’m surprised that this book:

    “”This book is a complete and encyclopaedic synthesis of problems and themes in self-affinity, fractals, multifractal geometry and globality. … a very exhaustive and complete bibliography on the different connected subjects (with more than 500 references) may be very useful for researchers or users.” (Michèle Mastrangelo-Dehen, Mathematical Reviews, Issue 2003 a)”
    http://www.amazon.com/Gaussian-Self-Affinity-Fractals-Benoit-Mandelbrot/dp/0387989935/ref=sr_1_5?ie=UTF8&s=books&qid=1236707560&sr=1-5

    isn’t on the rec’d list.

    others, from Mandelbrot:
    http://www.amazon.com/s?ie=UTF8&keywords=Benoit%20Mandelbrot&index=books&page=1

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  32. “There are lots of short stories that describe sales tactics, idiot buyers, and more.”–dh

    “idiot buyers”, also, I’m surprised more stories, about these catz, haven’t been penned..

  33. prschmitt says:

    I’m reading Traders, Guns and Money right now; It should be required reading for all regulators of these ‘markets’.
    From what I’ve read so far, a major contribution toward the solution of our economic woes would lie in one word:
    RICO!
    It amazes me the Kabuki dance that Wall Street types do to justify their parasitic antics, and the sycophantic excuses the wannabes and toadies make for them.

    And speaking of toadies..

    Who’d you most desire to take an iron pipe to the face of:

    Kudlow, or Kneale?

  34. Dervin says:

    But how much of this is a result of the three i’s – innovators, imitators and idiots.
    You’ll have one smart guy figure out a glitch in the market and take advantage and make a ton of money.
    You’ll have somebody else figure out what the first guy did and copy him and make a nice bit of money.
    Then you’ll have everybody else try to cash in on the glitch and thus ruining the glitch for everybody.

  35. steel breeze says:

    joseph.price Says:
    March 10th, 2009 at 11:16 am

    As a physicist who used to work in a US investment bank (until it went bankrupt in spectacular style), my view is that the tools of physics are very poorly suited to the world of finance.

    This is a view that Emmanuel Derman also shares in his book ( #4 in Barry’s list ).

    One wonders why quants were useful to i-banks and hedge funds?

  36. joseph.price says:

    steel breeze:

    Economists where useful to banks and hedge funds in the same way priests were useful to the feudal aristocracy. The quants were the alter boys – getting everything organised and occasionally submitting to a vigourous rogering

  37. joseph.price says:

    sorry about the spelling

  38. Mr Beefy says:

    Quick question – shouldn’t these books have been read when they came out? It would seem that their ideas would have been more effective ex ante. :).

  39. Beefy,

    they never made The List:

    A Fine Balance by Rohinton Mistry
    fiction

    Fall on Your Knees by Ann-Marie MacDonald
    fiction

    The Corrections by Johnathan Franzen
    audio cassette fiction, fiction

    Cane River by Lalita Tademy
    fiction

    Stolen Lives – 20 Years in a Desert Jail by Malika Oufkir and Michele Fitousi
    365.45 OUF

    Icy Sparks by Gwyn Hyman Rubio
    Compact Disc Fiction, fiction

    We Were the Mulvaneys by Joyce Carol Oates
    fiction

    House of Sand and Frog by Andre Dubus III
    fiction, large print fiction

    Drowning Ruth by Christina Schwarz
    fiction

    Open House by Elizabeth Berg
    fiction, large print fiction


    http://www.neptunepubliclibrary.org/oprah.htm
    ~~

  40. leftback says:

    “One wonders why quants were useful to i-banks and hedge funds?”

    Because the i-bankers and hedge funds could use the quants to con inwestors out of their cash.
    2 and 20 baby. it’s all about the fees…

  41. Because the i-bankers and hedge funds could use the quants to con inwestors out of their cash.
    2 and 20 baby. it’s all about the fees…

    not more complex than that, nice sum, lb..

  42. arogersb says:

    Check the book Inventing Money, the story behind LTCM.

  43. Jojo says:

    Wired magazine has a good Quant article this month:

    WIRED MAGAZINE: 17.03
    Recipe for Disaster: The Formula That Killed Wall Street
    By Felix Salmon Email 02.23.09

    In the mid-’80s, Wall Street turned to the quants–brainy financial engineers–to invent new ways to boost profits. Their methods for minting money worked brilliantly… until one of them devastated the global economy.

    http://www.wired.com/techbiz/it/magazine/17-03/wp_quant

    ALSO

    WIRED MAGAZINE: 17.03

    Road Map for Financial Recovery: Radical Transparency Now!
    By Daniel Roth Email 02.23.09

    The financial world doesn’t need new regulations. It needs radical transparency.

    http://www.wired.com/techbiz/it/magazine/17-03/wp_reboot

  44. ben22 says:

    @LB

    It wasn’t just the hedge funds that used the quants to get money from suckers, check out the Ameriprise “Active Portfolio’s” fund of funds line up.