Revenge of the Nerd

Given the tautologous statement "you cannot predict the future", I can either predict tomorrow's weather by flipping a coin or looking at weather satellite data. Reasonable people would expect that one would be right more often with the later approach than just flipping coins (although some would argue that you are better off flipping the coin instead of relying on the weather man, but you get the point). Quant models are analogous to satellite data in weather prediction - more likely to predict the future but still fallible. This fallibility was lost sight off and everyone followed the quant models like lemmings. In this mad sprint, the quants played a role in overselling the quant approach. Now they have a role ito play in resurrecting the models' reputation.

I find it amazing that that quants are taking part of the blame for the credit crisis and growth of the securitized debt markets. what about shareholders who screamed for more profits and rating agencies that slapped AAA ratings on all these instruments in order to sell more? Its like saying game designers are responsible for high school shootings. The fact is that quant finance still has little influence on corporate decision making. its up to management to prudently allocate capital. everyone knows that you should not cancel the insurance on your house even if there has not been a natural disaster in the last 5 years.

It seems to me like he was advertising his $18,000 certificate program rather than trying to fix the wall street. And I can't believe he deliberately left out Berkeley-Haas MFE, which has been ranked the highest for several years consecutively by Global Derivatives. A degree program is more respected, highly valued, and opens for much better opportunities in this industry than a certificate program. Wilmott himself is got a PhD, way to go!

Statements like "Neither the maths nor the models based on the maths were erroneous. The only erroneous parts were, of course, the assumptions" make me very nervous.

It shows a lack of understanding of models. Under the best of circumstances models are representations of truth. The finance models do not capture the truth otherwise they would have seen the mayhem. You can argue the assumptions were wrong. To that my counterpoint is that the "Newton's second law of motion" that Wilmott used to make his point does not need any assumptions. You know the force and mass, the acceleration is known. In Finance, you know neither the force nor the mass. All you have is a bunch of variables varying albeit with some relationship among them. So you force a mathematical framework of stochastic processes and give it a veneer of truth. It might work most of the time but not all the time. Truths are valid all the time.

The Quant community using tools from math came up with products that seductively seemed to promise outsized returns. The persons on the other side of this transaction - those who bought into these products, the companies, managers, etc. - should have exercised the age old caution "when something seems too good to be true, it probably is".

Creating value or in other words increasing the size of a pot of gold is hard, especially on the Main Street - read the businesses making actual goods and services. The Quant community felt (or at least I hope it felt) it could come up with tricks that would make the process of wealth creation easy on the Wall Street - read the purveyors of capital. But what they fail to recognize, is that all value created on Wall Street eventually comes from the Main Street. Capital can extract its rent but it makes no contribution to the actual process of value creation.

The point is that those who bought into these products are culpable in no less measure. Hence I share Mr. Wilmott's concern that not enough is being done to add regulatory filters. Those who profited from these products - the companies and managers - want to wait for the storm to pass before they start down the same path again.

While I agree with the general direction of Mr. Wilmott's article, I take exception with his analogy that draws upon Newton's second law of motion. As someone with an engineering background and masters' degrees in Lasers and Applied Physics (Princeton), Statistics (Iowa State University) and MBA (Cornell University), I know it is a stretch to say that we know what can be called "Newton's second law of motion" of finance.

What we have can at best be called a framework, a very squishy framework that can fitted to any given state of the world. This framework is akin to knowing what a house should be constructed: walls (four, maybe), a roof (flat, slanted, etc.), a door (one, two, or none), windows (one, two, or none).

Carrying this analogy further, the quants forecasting tomorrow's weather built houses to stand up to their expected tomorrow???s conditions. But, Mother Nature does not like hemmed in by mere mortals, however smart they might be. Thus, the current carnage.

For quants to be right more often than wrong, they have to look at macro trends and anticipate all the possible outcomes...something not humanly possible. And ultimately, the managers need to understand that these are after all methods and tools to make money that need to be scrutinized. Alas, as Mr. Wilmott points out, the outrage has been more of a whimper.

Vinod Kumar

I believe this man stole most of the I Q's out there.

The models are fine until government changes the rules or that the underlying banking system is bankrupt.

However, it allows for other great theory and speculation that have so many riled when addressing derivatives. Obviously the formulation and practical exercise of writing some forms of financial vehicles is beyond paper and pencil...

What any good model (today) should and does allow for are elaborated means of the nature and cost of energy basis to consider the ecological model of converting the energy system to go green.

Speculation in energy futures that peak prices beyond the ordinary while forcing a conversion to alternative energy means is taking hold. In the simplest sense the forced escalation of oil causes greater and greater investment in new energy markets and at the cost of the basis from which the old energy market is settled to exist under.

In time there will no longer be any choice but only to use alternative energy. Smart grid technology is a worthy example of utilizing the power grid to distribute only the energy required and thereby reducing transmission cost.

Wireless technology is likely the most conservative model there is considering the energy required to run a cell phone as one example in an emerging decade of low powered devices that use a fraction of the energy its counterpart once required.

Quants make models to price instruments. They do not make predictive models. The models they make are based on certain assumptions. The corporate managers then use models to "impress" higher managment. For them it is this beuatiful black box which can churn out a number and make everyone happy and get themselves promoted. And then they go further and try to use them as predictive tools. The credit crisis was the result of these models being passed on to managers who probably hold great MBA degrees but do not understand mathematics. There is always this misguided notion with non quant managers of understanding the "big picture"..They do not understand that their "big picture" changes with the type of eye glasses you wear. I think what led to the credit crunch is that the quants developed the equivivalent of "nuclear technolgy" for peaceful means and it fell into the hads of "ignorant greed" of corporate managers. They inadvertantly made it inot a 'nuclear bomb' and blew themselves up in the scheme of things. Please, for the future dont fool yourselves about any big picture. If you need any educated advice take it from the quants!! Dont blame them for this mess!!

At every place I have worked and in every encounter with colleagues at any other financial institution--including many that failed, the pricing and risk measurements both business people and the more senior quants treated the output of the various equations with plenty of skepticism. Big, sometimes heated arguments, occur between different groups about the value of parameters like correlations between different currency movements and many other assumptions. The quants that fit the description of 'lacking a holistic view' as described by Wilmott generally do no harm. They just have limited career advancement opportunities, just like any engineer who can program and solve differential equations, but cannot formulate problems.

Those who blame quants offer no other way of evaluating risk. During the days when the banker 'looked you in the eye' before making a loan, many banks failed and people who were born with the wrong skin color or heritage had a tough time getting a loan.

We are mistaken to think that the "quants" are the only analysts/scientists/engineering component of any field that have had their technical or mathematical work mis-interpreted or have had their warnings or cautions brushed aside by over-zealous management who see something they can use. This is in fact a common issue that people working on the more technical sides of things need to learn to work with in any field, as well as the reality of the application of their knowledge in the real world (getting back to the original article). And frankly, it is man's folly to believe that we can truly accurately "model" or "predict" any complex system, not just financial systems, especially those where people are involved. Should the people proposing the financial models have shouted louder about the issues? Hind sight is always crystal clear. The only ethics that should be questioned are those who made the decisions, cashed the checks, and sank the entire ship.

This is one of the few articles I've seen which discusses the role of universities and their professors (even if a bit indirectly) which produced all those failed quant geeks. It points to a failure in the higher educational system, not only on the quant side, but, perhaps more importantly, on the morals and ethics side. Where is the leadership in the major universities on all these issues?

I certainly agree with Mr Wilmott on one thing: "where is the anger?". There should be a giant pile of rotting finanial officers corpses somewhere in plain sight as an example!

It just goes to show you that you can teach this financial math, but bottom line, you can't teach morals, honesty, and integrity, to a bunch of dishonest rapscallions and whores who don't care about anything but their bonuses. What these people did is nothing short of financial terrorism, and all responsible/involved should be spending a very long time in a very nasty prison.

Any financial model that has withstood the test of time, was wrong to begin with.

The reality is quantatative finance is here to stay, and the question is one of management, (and some may add regulation to that category). Who was to blame? When Nick Gleason of the ill-fated Barings Bank when bust withthe whole bank who was to blame? It was the management as well as Gleason> Let me emphasise, the whole pack of greedy suckers who allowed him free reign because he was the 'Goose that was bringing in the golden egg' in the form of the managerss' bonuses, plus his own of course, as he is not a benevolent agency. The fact is that greed is the principal culprit, unchecked and unregulated greed, and this affects everyone at multiple levels. So I blame everyone, even the 'dumbed-down' general public who invest so much trust in dubious financial people and who want to believe that their mouthing politicians and representatives are looking out for their best interests. The truth is, each one of us needs to take some responisbility here. We reap what we sow. An old proverb, but eternally true. And, finally, like Paul Wilmott, I don't think we'll ever really learn. SUch are the cycles of life. And in Greek symbols or Greek myths, its all the same show. (Perhaps we should all learn Greek? Any takers?)

The reality is quantatative finance is here to stay, and the question is one of management, (and some may add regulation to that category). Who was to blame? When Nick Gleason of the ill-fated Barings Bank when bust withthe whole bank who was to blame? It was the management as well as Gleason> Let me emphasise, the whole pack of greedy suckers who allowed him free reign because he was the 'Goose that was bringing in the golden egg' in the form of the managerss' bonuses, plus his own of course, as he is not a benevolent agency. The fact is that greed is the principal culprit, unchecked and unregulated greed, and this affects everyone at multiple levels. So I blame everyone, even the 'dumbed-down' general public who invest so much trust in dubious financial people and who want to believe that their mouthing politicians and representatives are looking out for their best interests. The truth is, each one of us needs to take some responisbility here. We reap what we sow. An old proverb, but eternally true. And, finally, like Paul Wilmott, I don't think we'll ever really learn. SUch are the cycles of life. And in Greek symbols or Greek myths, its all the same show. (Perhaps we should all learn Greek? Any takers?)

I have a degree and engineering and a masters in applied math. And at the end of the day all quantitative analysis of financial assets is pure, unadulterated bullsh-t. They simply cannot be abstracted in any way shape or form from the ugly complexities and monsterous unknowns of the marketplace.

Imagine that I told you to draw me a house 250ft long, 140ft wide and between 8 to 12 ft tall. Then I tell you your drawing must match in every detail, a house currently being constructed by a contractor - only you are never permitted to actually SEE the house the contractor is building or communicate with the contractor in anyway - you've never even met the guy. YOU must ASSUME all kinds of things - materials, colors, interior decorations... what are the odds that the house you came up with matches the one the contractor built? now you are beginning to understand math and finance.