Thursday, June 4, 2009

The Power of the Quants.

. Thursday, June 4, 2009

Really interesting article from Newsweek on Paul Wilmott, an Oxford-trained mathematician specializing in quantitative finance. Wilmott seeks to train newly minted physics, financial engineering and math PhD's who are out working in finance that there is a hell of a lot more to finance than simply mathematical model-building and equations. Here is an excerpt, but do check out the entire article. Worth the read.

Imagine an aeronautics engineer designing a state-of-the-art jumbo jet. In order for it to fly, the engineer has to rely on the same aerodynamics equation devised by physicists 150 years ago, which is based on Newton's second law of motion: force equals mass times acceleration. Problem is, the engineer can't reconcile his elegant design with the equation. The plane has too much mass and not enough force. But rather than tweak the design to fit the equation, imagine if the engineer does the opposite, and tweaks the equation to fit the design. The plane still looks awesome, and on paper, it flies. The engineer gets paid, the plane gets built, and soon thousands just like it are packed full of people and sent out onto runways. They fly for a while, but eventually, because of that fatal tweak, they all end up crashing.

In a way, this is what's happened in quantitative finance. The planes are the complex derivatives—like collateralized debt obligations—that now lie smoldering on the balance sheets of banks. The engineers are the "quants": those math and science Ph.D.s who flocked to Wall Street over the past decade and used mathematical models to build these new investment products. These are the people Warren Buffett was talking about when he said, "Beware of geeks bearing formulas" in his letter to shareholders this year. The quants aren't entirely to blame for the financial meltdown; there's plenty of guilt to be shared by regulators, top executives and the investors who bought the instruments the quants created. Yet while aeronautical engineers who willfully designed a faulty plane might be on trial for criminal negligence, Wall Street's math gurus are, for the most part, still employed. Strangely, the banks need quants more than ever right now. If anyone's going to figure out how to price these toxic assets, it's them. Quantitative finance isn't going away, but it is in desperate need of reform. And one man—a math geek himself—thinks he knows where to start.
This is not only true of the world of finance. This can also be extended to economics and political science. Are some rising academics simply bending equations and formulas to fit the real world, implying causality and correlation where none really exists? In the face of mounting pressures to public or perish, how much of what is put out there in our scholarly journals dishonest, mathematical model building simply for the purposes of another publication and veiled by mathematical complexity and greek symbols? 

(ht: MR)

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The Power of the Quants.
 
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