The Quants: Formula for a Meltdown(online.wsj.com)
online.wsj.com
The Quants: Formula for a Meltdown
http://online.wsj.com/article/SB10001424052748704509704575019032416477138.html
3 comments
There are lots of examples of techniques that won their inventors Nobels in Econ (and sometimes even sciences) going on to being used to make lots of money in finance.
A famous example being the Black Scholes model for option pricing, which won its inventors the Nobel Prize in Econ. Myron Scholes went on to create one of the first 'quant' funds (LTCM) back 1994 (which flamed out spectacularly during Russia's crisis in 1998.)
A famous example being the Black Scholes model for option pricing, which won its inventors the Nobel Prize in Econ. Myron Scholes went on to create one of the first 'quant' funds (LTCM) back 1994 (which flamed out spectacularly during Russia's crisis in 1998.)
Lots? Can you name a few beyond Black-Scholes that are applicable to derivatives trading? From looking at the list of Nobel prize winners, I can't.
Interestingly, in a course on statistical physics, the prof showed that by performing the correct transformations on the central equation of the Black-Scholes model, you can actually reduce it to a plain diffusion equation. He wondered whether it was reasonable to hand out a Nobel prize for that.
Interestingly, in a course on statistical physics, the prof showed that by performing the correct transformations on the central equation of the Black-Scholes model, you can actually reduce it to a plain diffusion equation. He wondered whether it was reasonable to hand out a Nobel prize for that.
To name a few: Engle, Granger, Merton, Markowitz, Miller, Sharpe. Shortly, they're used frequently in the area of risk management.
With some good faith you can also take into account the assymetric informations study, so Akerlof, Spence, Stiglitz, Vickrey; also, if you're big enough to move the prices by your orders, the game theory applies: Selten, Nash, Harsanyi.
As for the Black-Scholes, from what I understand, the biggest insight is that the volatility of the stock is basically the risk.
The problems with the non-constant volatility, led to studying different (ARCH, GARCH) models and work appreciated by a Nobel in 2003.
With some good faith you can also take into account the assymetric informations study, so Akerlof, Spence, Stiglitz, Vickrey; also, if you're big enough to move the prices by your orders, the game theory applies: Selten, Nash, Harsanyi.
As for the Black-Scholes, from what I understand, the biggest insight is that the volatility of the stock is basically the risk.
The problems with the non-constant volatility, led to studying different (ARCH, GARCH) models and work appreciated by a Nobel in 2003.
Interestingly, when Markowitz invested his own money, he invested 50% in stocks, and 50% in bonds. If the creator did not believe in his own creation, I don't think anyone should. BTW, Engle's work is kind of useless in the real-world...
The article struck me as anti-intellectualism run amok. I didn't even see a hint of anything indicating that quants were especially to blame.
I see this as a scape goating of the quants. Not the mismanagers who hired and profited from the quants. The culpability of the mismanagerial classes are being whitewashed away.
I feel the same way. They make it sound like quants are these high falutin half-Gordon Gekko/half-Charlie Epps figures who use their sheisty siren call of maths to seduce the otherwise noble and innocent investors into foolish endeavors. That's simply not the case: it was the other way around.
The OP source is one of the organs of record for a specific political set and this is probably the outlines of the (official) emerging sacrificial goat theory for the collapse. The "anti-intellectual" aspect is likely incidental beyond its nice fit with a strategy designed to deflect the certain anger and energy of the ripped off population.
Yet another article blaming the poor quants. Anyone with nonzero experience in finance knows that quants have no power and earn no respect. Of course quants know that models have limitations, but if you tell your boss that one should be conservative, the only thing you will attain is to get yourself fired. The ones to be blamed are the ones with decision-making power, and everybody knows that quants have as much decision-making power as the IT guys.
At least they talk about Aaron Brown. In any case, I was expecting more from the WSJ. They used to be better than this...
At least they talk about Aaron Brown. In any case, I was expecting more from the WSJ. They used to be better than this...
In any case, I was expecting more from the WSJ.
Amen to that. The article mentions "The secretive trading operations within banks that use large doses of leverage, or borrowed money, to make huge bets on the market". This is just not true -- and the WSJ should know that. You can generate leverage without borrowing a dime. Options contracts can be highly leveraged yet involve no borrowing. Futures contracts can be highly leveraged with no borrowed money. In both cases the exchanges have put in place elaborate mechanisms to ensure a losing side can pay up, and guarantees the winning side will collect even in case of complete counterparty failure. There is no borrowing here but there's plenty of leverage.
Unfortunately a lot of the bad trades behind the meltdown (AIG derivatives, etc.) were basically private contracts, with no exchange mechanisms in place to mitigate counterparty risk. That's also one reason nobody knew what was really going on.
Amen to that. The article mentions "The secretive trading operations within banks that use large doses of leverage, or borrowed money, to make huge bets on the market". This is just not true -- and the WSJ should know that. You can generate leverage without borrowing a dime. Options contracts can be highly leveraged yet involve no borrowing. Futures contracts can be highly leveraged with no borrowed money. In both cases the exchanges have put in place elaborate mechanisms to ensure a losing side can pay up, and guarantees the winning side will collect even in case of complete counterparty failure. There is no borrowing here but there's plenty of leverage.
Unfortunately a lot of the bad trades behind the meltdown (AIG derivatives, etc.) were basically private contracts, with no exchange mechanisms in place to mitigate counterparty risk. That's also one reason nobody knew what was really going on.
Whoa, this really touched a nerve. I think everyone should step back and see that this is an excerpt from a book. I thought it was an interesting snippet but I would have like to see more.
Hyperbole as a style form is all and well, but this is just misrepresenting the truth. This journalist didn't rethink what he was writing for even a second.