Quants



$27.00
Customize It



Hardcover
337 pages
ISBN 9780307453372 Published Feb. 2010
Crown Business
See all formats


Quants
How a New Breed of Math Whizzes Conquered Wall Street and Nearly Destroyed It
By Scott Patterson 

Related Blog Posts
Models Behaving Badly
Posted March 22, 2012 11:10 a.m. by dylan
In - 800 CEO Read Blog

Models Behaving Badly has nothing to do with TMZ or a Harlequin novel. The models at the heart of this book are not beautiful people that fashion designers drape their creations over, but financial models that financiers and money managers try to drape reality over in order to make predictions about the market—and, of course, gobs of money.

The author, Emanuel Derman, is a former theoretical physicist and used to be the head quant (quantitative analyst) at Goldman Sachs, so this is not cheap or easy entertainment. You have to work for it, and your brain is going to hurt at times. I'm not even sure that I fully understood everything in the book (For instance, did you know that there's a resemblance between the Law of One Price in finance and Einstein's principle of relativity? Don't worry, he'll explain.), but I do think I came out of it with a better understanding of the world. In the first 45 pages, he delves into Spinoza, Goethe, the nature of good and evil, the luminosity of stars, and much, much more. But why? Well, to discuss the nature of reality versus the illusion of reality, of course—a discussion he uses to delve into an exploration of metaphors, models and theories that runs throughout the book.

I first came across Emanuel Derman in Scott Patterson’s The Quants: How a New Breed of Math Whizzes Conquered Wall Street and Nearly Destroyed It. He mentions him as the coauthor of The Financial Modelers' Manifesto, which was "an ethical declaration for scientists applying their skills to finance," and which is excerpted at the end of the book.

Our experience in the financial arena has taught us to be very humble in applying mathematics to markets, and to be extremely wary of ambitious theories, which are in the end trying to model human behavior. We like simplicity, but we like to remember that it is our models that are simple, not the world.

Many, including Patterson, laid much of the blame for the financial crisis on the quants of Wall Street. That seems a bit unfair to me. Firms were giving the best and brightest minds absurd amounts of money to come to Wall Street and devise these models, and they used those models recklessly and irresponsibly to ignore the real world of risk around them, over-leverage their positions, and nearly bring down the entire financial system they themselves built. It would be akin to Zeus, the god of sky and thunder, hiring meteorologists to come up with weather models, using those models to devise the storm of a century, and then blaming the meteorologists when the storm nearly destroys the world. After all, Zeus knows way more about how to control the weather than a meteorologist. Like the big firms on Wall Street, he literally creates the climate!

As Derman writes of economic and weather models, "An economic model aims to do for the economy what the weather model does for the weather. ... But an economy is an even more abstract concept than the weather." Derman loves his metaphors, and so do I. He begins Chapter 2 with this doozy:

Sleep is the interest we have to pay on the capital which is called in at death; and the higher the rate of interest and the more regularly it is paid, the further the date of redemption is postpones.

So wrote Shopenhauer, comparing life to finance in a universe that must keep its books balanced.

If you want a straightforward business book to solve a particular problem, this is not the book for you. But if you're looking to go on a metaphysical journey to explore the nature of reality and modern finance, this is going to be a fun trip.



Bloomberg Picks 30
Posted Nov. 19, 2010 9:02 a.m. by dylan
In - 800 CEO Read Blog

Here's a list we missed late last month. Though the post is rather cryptically titled Hellhound Bites Citigroup, Schwarzman Finds Gold Mine: Top Business Books, Bloomberg's James Pressley explains exactly why they put the list together:

With so many business books being published each month, we’re often asked for recommendations. Here are 30 of our favorite hardbacks published this year.

I've taken out the author's brief descriptions of each book (head on over to the original post for those), and have taken the liberty to break the books up into a few categories. You'll notice while perusing the titles that the list tends toward larger narratives (many of the financial crisis), biographies and financial history, which I'm a big fan of, and I think makes a lot of sense for Bloomberg and its readers.

A quick note: Many of the books I put in the "Economics" category are, at least in part, about the economic crisis. The books I chose to list in the "Economics" category are those that offer a detailed prescription to the crisis, rather than just documenting the causes and events of it (not that the latter is a lesser task). The books in the "Economics" category were also, by-and-large, written by economists, while those in the "Histories & Narratives of the Economic Crisis" were written by journalists and participants on Wall Street.

Histories & Narratives of the Economic Crisis

Economics

Financial History & Biographies

Other

Looking over the list, I'm reminded once again what a good year this has been for business books.

If you're an entrepreneur looking for ideas or nuts-and-bolts books on business, this list may not be a great help to you (We'll provide you one that will be on December 15th). But if you're an investor in or student of markets and business, it doesn't get much better than this.



Books as Intellectual Assets in an Economic Discourse
Posted March 18, 2010 3:30 a.m. by dylan
In - 800 CEO Read Blog

Michael Lewis's latest book, The Big Short: Inside the Doomsday Machine, was released this week to a lot of media attention and bestseller lists. We'll review the book more in depth on this site and elsewhere over the coming weeks, but its very release is what's giving me hope this week.

You see, for all the doom-and-gloom surrounding publishing these days, publishers themselves have done a quietly masterful job of finding books that put the Great Recession, and what caused it, in focus over the last year and a half—Michael Lewis being but the latest (albeit one of the finest) voices in the choir that publishers have been directing. And I think it is a very important task they're accomplishing. In a media environment dominated by the 24 hour news-cycle, and inundated with soundbites and tweets that flutter into the crowded cultural ether, soon to be forgotten, it is important that someone documents what went wrong in depth—where, why, when and how—and, dare I say, on paper.

And we need these books and the discussions they raise not only in academic circles, not only in and our intellectual and political culture; we need it in our popular culture. An academic dissection of what exactly went wrong, by the numbers, is important. But we need more than an economist's dissertation on the situation (though many economist's have written excellent and accessible books on the crisis). Newspapers and magazines can document the events as they're happening, and often provide a invaluable insight or angle that sheds light on what's going on. But the story is ever-changing, always evolving, and their job is to follow it, to report on its latest developments—sometimes at the expense of the larger picture (though some of the best books on the recession have been from journalists that stepped back from it all to distill that picture). Cable news and the echo chamber of the political blogosphere have their place, but we need more than talking points and counterpoints.

And this is what publishers have been so good at: finding authors and books that can inform and influence all of those discussions (and, at the same time, transcend them) and then getting them out there to do so. The are capturing the larger narratives by finding authors that can write them. They have told many stories, by many authors, from many different angles, exposing the different elements and individuals involved in the crisis. The books they've put out are, generally, well-researched and written well enough to hold serious intellectual weight, but not so obscure that the general public can't understand what's going on. The stories in these books are complicated, and often insane, but these authors are making them accessible, and publishers are making them available.

It may sound like hyperbole, but I think these books can help better not only the business and financial worlds, but the world itself. They tell a story we'll need to hear before we can correct the course our economy has been on. I sincerely hope those with their hands on the levers of power are listening to (and reading) them as they're discussing how to do so.

Here is a quick list of some of the books that I'd suggest (if you have some, please add them in the comments section):

That's just a start, and I know I'm missing a lot... probably some big ones. And that's not even getting into those books that focus more on how we recover, reset and reform our financial system (and individual companies) now that all the damage has occurred—books like Anna Bernasek's The Economics of Integrity that discuss solutions on a macro level and the Boston Consulting Group's Accelerating Out of the Great Recession that do so on a micro level.

Andrew Ross Sorkin concluded his book, Too Big to Fail, with a great story:

When the post-bailout debate was still at its highest pitch, Jamie Dimon sent Hank Paulson a note with a quote from a speech that Theodore Roosevelt delivered at the Sorbonne in April 1910 entitled "Citizenship of the Republic." It reads:

"It is not the critic who counts: not the man who points out how the strong man stumbles or where the doer of deeds could have done better. The credit belongs to the man who is actually in the arena, whose face is marred by dust and sweat and blood, who strives valiantly, who errs and comes up short again and again, because there is no effort without error or shortcoming, but who knows the great enthusiasms, the great devotions, who spends himself for a worthy cause; who, at the best, knows, in the end, the triumph of high achievement, and who, at the worst, if he fails, at least he fails while daring greatly, so that his place shall never be with those cold and timid souls who knew neither victory nor defeat."

It was a remarkable quote for Dimon to have chosen. While Roosevelt's words described a hero, they were deeply ambiguous about whether that hero succeeded or failed. And so it is with Paulson, Geithner, Bernanke, and the dozens of public- and private-sector figures who populate this drama. It will be left to history to judge how they fared during their own time "in the arena."

In my opinion, publishers are doing a wonderful job of documenting "the arena" for us all (and hopefully those inside the arena) to consider... and for history to judge.



The Quants
Posted Feb. 25, 2010 2:12 p.m. by dylan
In - 800 CEO Read Blog

I've not yet finished reading Scott Patterson's The Quants: How a New Breed of Math Whizzes Conquered Wall Street and Nearly Destroyed It, but I'd like to go on record now in disagreement with The Economist's review of the book. I do agree that Patterson's prose can get a bit "purple" in places, but I think his focus on the quantitative models developed and used on Wall Street over the last three decades is an important one. And the way he explores the topic—through the stories of the individuals who created those models—keeps the reader engaged in a tale that might otherwise turn too academic for most.

Patterson also tells of individuals in the "quant" community who have warned against relying on the models they helped create, and he makes good use of their voices in supporting his conclusion that there is no absolute truth in those models—that there is not a science or equation with which to predict and play the market. Beyond referring to the more popular dissidents, such as Nassim Nicholas Taleb and Benoit Mandelbrot, he refers to two I have not come across, Paul Wilmott and Emanuel Derman, and their Financial Modelers' Manifesto:

It was a cross between a call to arms and a self-help guide, but it almost amounted to something of a confession: We have met the enemy, and he is us. Bad quants were the source of the meltdown.

"A spectre is haunting markets—the spectre of illiquidity, frozen credit, and the failure of financial models," they began, ironically echoing Marx and Engels ...

What followed was a flat denunciation of the idea that quant models can approximate the Truth:

Physics, because of its astonishing success at predicting the future behavior of material objects from their present state, has inspired most financial modeling. Physicists study the world by repeating the same experiments over and over again to discover forces and their almost magical mathematical laws. ... It's a different story with finance and economics, which are concerned with the mental world of monetary value. Financial theory has tried hard to emulate the style and elegance of physics in order to discover its own laws. ... The truth is that there are no fundamental laws in finance. And even if there were, there is no way to run repeatable experiments to verify them.

In other words, there is no single truth in the chaotic world of finance, where panics, manias, and chaotic crowd behavior can overwhelm all expectations of rationality. Models designed on the premise that the market is predictable and rational are doomed to fail. When hundreds of billions of highly leveraged dollars are riding on those models, catastrophe is looming.

That quote, I think, pretty much sums up the reason this book is important. We have all heard that the problems on Wall Street stemmed from firms over-leveraging their positions, but we don't often discuss the model they were leveraged on. The more books addressing the issue, the better—I would think. A great book on the subject that was vastly under-appreciated when it was published, and that I'm surprised hasn't come into the conversation since, is Richard Bookstaber's A Demon of Our Own Design, which we named the best Finance and Economics book of 2007 in our first annual 800-CEO-READ Business Books Awards. The book came out a year before Nassim Nicholas Taleb's more popular Black Swan, and I think it's just as important. (And both men were on Wall Street to witness the rise of "the quants" in the '80s. Both, in fact, were among their early numbers.)

A Demon of Our Own Design begins tantalizingly:

While it is not true that I caused the two greatest financial crises of the late twentieth century—the 1987 stock market crash and the Long-Term Capital Management (LTCM) hedge fund debacle 11 years later—let's just say I was in the vicinity. If Wall Street is the economy's powerhouse, I was definitely one of the guys fiddling with the controls. My actions seemed insignificant at the time, and certainly the consequences were unintended. You don't deliberately obliterate hundreds of billions of dollars in investor money. And that is at the heart of this book—it is going to happen again.

It happened again, alright, and Patterson's book does a good job of documenting it on the other side. Patterson doesn't have the narrative genius of a Micheal Lewis or Andrew Ross Sorkin, and The Quants is no Liar's Poker or Too Big To Fail, but Scott Patterson has turned in a valiant debut effort and The Quants is a very good book.




More on this book