宽客人生：是谁搞垮华尔街的?

上了时代周刊的宽客

It’s not QUANTum physics anymore

For more than two dozen years, there have been particle physicists manning the booths at all of the top financial organizations. They are no longer studying General Unified Theory, quarks, and particle accelerators. They are using their expertise with mathematics and logical reasoning to forecast what the economy is going to do next. Their game isn’t just buying and selling – it’s correlations and risk factors, interpreting bell curves and manipulating the slightest percentage of an advantage to make money for their employers and clients.

Surprising, isn’t it? Not so much, if we go back to the root of the job. America and Russia’s little Cold War half a century ago bred an entire math and science generation…when the Cold War ended, there were only so many professors needed. Many of the scientists decided to forgo the “beauty” of pure science and made their way to Wall Street. They became “quants”, masters of Quantitative Analysis and “risk management”.

Take, for example, Emanuel Derman, an academic with a degree from Columbia and a job at Oxford, who spent 17 years at Goldman Sachs. Indeed, a large percentage of M.I.T.’s math and physics graduates went on to work in Wall Street in recent years, bartering away their souls for money.

Quants utilize complicated mathematical equations involving the greek alphabet to detangle the stock market – unfortunately sometimes with the bad consequences. For example, David X. Li’s Gaussian copula function, which allowed hugely complex risks to be modeled with ease and supposed accuracy, was seen as a godsend by the Wall Street community when it was first invented. After all, the equation “made it possible for traders to sell vast quantities of new securities, expanding financial markets to unimaginable levels.”

Li was on the short list for a Nobel Prize just a few years ago. Today, however, he has gone into hiding in China; some are blaming the huge cracks in his function for the sub-prime mortgage meltdown and subsequent downturn of America’s economy.

Nevertheless, it was not necessarily the fault of Li and his equation, but rather the traders and financial gurus who placed an excess amount of trust in a mathematical formula. Even Li himself, who is no longer working in the field, said that “the most dangerous part is when people believe everything coming out of it”. Now the entire issue of having quants in the financial sector at all has sparked a giant debate. On one side, some argue that the work that quants do is useful if seen as a model, a guideline, not something set in stone. On the other hand, we have Nassim Nicholas Taleb.

Taleb is a man of set opinions: “I think physicists should go back to the physics department and leave Wall Street alone.” In contrast to many quants, who base their stock-market assumptions on the bell curve formula where the average is most likely, the former trader believes that our nation’s financial history is based far more upon unpredictable, unmodeled events than on the mean. The charitable Warren Buffet apparently agreed last fall on The Charlie Rose Show, when he said “All I can say is, beware of geeks bearing formulas”.

That sentence might best sum up the placing on the hierarchy of the imported physicists. They do a lot of work, but they do not get as much credit as the traders or the brokers who are the face of the company. And in the end, much of the blame for economic downturn is being placed on them. People say that they should have been able to perceive the correlations between the sinking housing market and the sinking economy. “They forget about the concrete reality the figures are supposed to represent.” Basically, Wall Street is telling the quants that stuff here isn’t as easy as it is in a high school calculus class.

However, this might be part of the problem. Too many bankers, who look down their noses on the quants, do not remember anything from their high school calculus classes. They don’t let any of the quants make the actual decisions, and they don’t ask questions about the applicability of the models in certain contexts. Kai Gilkes of CreditSights, a credit research film, says that “we should blame the bankers who misinterpreted it.”

The entire situation is like the kid who sat next to you and copied all your homework without asking how you got to that point. When the test comes around, he was totally screwed.

The quants should not be run out of Wall Street, because ultimately they were doing valuable work that was correct a majority of the time. However, their faith in tenets of quantitative financial analysis should be shaken a little bit. The main problem with force-feed equation’s like Li’s or “the quant’s gold standard”, the Black-Scholes Model, is that everyone started using it at once, so everyone sunk with the ship. A species can’t live on without genetic diversification.

Maybe what the Wall Street needs are more quants and more models, not less.