Future of Financial Mathematics?

An anonymous reader writes "Nassim Nicholas Taleb, a famous 'Quant,' has long been a strong critic of the use of mathematics and statistics in the financial markets. He has been very vocal in his books The Black Swan and Fooled by Randomness. In his article on edge.org, he says 'My outrage is aimed at the scientist-charlatan putting society at risk using statistical methods. This is similar to iatrogenics, the study of the doctor putting the patient at risk.' After the recent financial crisis, wired.com ran an article titled 'Recipe for Disaster: The Formula That Killed Wall Street' in which the quant David Li and his Gaussian Copula were crucified — we discussed it at the time. Now, I've recently been admitted to a graduate program of good repute in Computational & Applied Mathematics. There is a wide range of subjects in which you can pursue your PhD, one of them being Financial Mathematics. I had a passing interest in it for quite some time. In the current scenario, how advisable it is to pursue a PhD in this topic? What would my options be five years down the line? Will the so-called 'quants' still be wanted by the banks and other financial institutions, or will they turn to more 'non-math' approaches? Would I be better off specializing in less volatile areas of Applied Mathematics? In short, what is the future of Financial Mathematics in light of the current financial crisis?"

Comments

Advice from a PhD student

[chillax137]

Don't pick your research area based on profitability or popularity. There are always "hot" areas of research but these things are usually cyclic. Pick something interesting that excites you, and that you can spend the next 4 (or 5 or 6 or 7) years working on.

Re:Advice from a PhD student

[Narpak]

or the next twenty-forty-sixty years for that matter. Depending on how long you live or when Cthulhu raises from the sea.

Re:Advice from a PhD student

[PopeRatzo]

Listen to chillax137, he's got it right.

My wife's a mathematician researcher. She's remarked to me several times lately that some of the big financial outfits have been picking people from the non-financial math areas, such as fluid dynamics, predictive analytics, combinatorics, etc.

They're looking for sharp, dynamic people more than a particular course of study or area of research. The secret is out that a lot of second-tier mathematicians went into financial math because they thought that would be their ticket to vast wealth and like a famous capitalist said, "First you get the money, and then you get the power, and then you get the woman."* In the current environment, people who strive to get a certain type of degree because they think it's going to make them rich are not so eagerly sought.

My first rule of preparation for career advancement: Don't learn how to do anything that you don't want to be doing. I figured that out long ago when I was trying to learn how to program SQL during a time when I was sick of my job. One night I realized that I would hate programming SQL all day, so I dropped it and put that energy into the stuff that I find fun.

A bit self-defeating

[russotto]

Reading up on the Wikipedia article on this guy...

"Taleb appeared to be vindicated against statisticians in 2008, as he reportedly made a multi-million dollar fortune during the Financial crisis of 2007-2008, a crisis which he attributed to the failure of statistical methods in finance "

But his thesis is that such events are fundamentally unpredictable. If he made a fortune, it means _he_ was able to predict it, well enough to profit for it. Which argues not that the events are unpredictable, but rather that his model is better.

Re:A bit self-defeating

[Jane Q. Public]

Distortions in the market, like over-leveraged corporations and too many risky investments hanging out, tends to make things predictable. After all, if you KNOW that the market for some commodity is over-priced, then you KNOW that sooner or later there will be a "market correction".

By and large, though, markets are unpredictable, and they need to stay that way. If markets were predictable, they would cease to exist... some one or a few would run off with all the money. To the extent that it has been "predictable" and made some corporations lots of money recently... as we have seen, that was largely due to manipulation and corruption, not the effects of free markets.

Re:A bit self-defeating

[the_other_chewey]

But his thesis is that such events are fundamentally unpredictable. If he made a fortune, it means _he_ was able to predict it, well enough to profit for it.

No. His "system" is indeed based on the assumption that such events are unpredictable. That's why he for years bet
simultaneously on a sharp increase and a sharp decrease in stock values - and ran slight daily losses, in the
anticipation and expectation that once such an event inevitably happens, the profits will more than make up for those
losses.

It worked.

He basically had no idea - and didn't care too much - when this (and what this "this" would be) would happen though.

Re:A bit self-defeating

[peragrin]

Actually markets are very predictable. every 10 years they go boom. Which part goes boom is varies but every ten years since Nixon they go boom.

The trick is that wall street likes unlimited growth. if you don't expand your business by 10% every year then you are a failure and your company should be punished. After 10 years at 10% growth you have over saturated the market by 100% and every company that got there with unstable books and balances collapses.

I forget exactly who and when but a walmart exec once stated. If we stop building new Walmarts we will go bankrupt. As they leveraged one walmart to build the next in a terrible endless pyramid scheme. Once the bottom bursts there is nothing holding up the top.

Indeed if you look closely to all the news reports on what happened to the banks that is exactly what happened. 5% failure of loans should be expected. However a handful of banks ended up holding that entire 5% as their portfolio. As they collapsed the rest of the banks were suddenly forced to cover them, and since they over extended themselves by laying off bad loans on a small group the rest of the banks couldn't take the weight.

the housing market the past 8 years was the same way. You can't have massive growth without massive contraction.

The dot com burst. was the same. unparalleled growth but questionable accounting.

Oh and I saw the housing market ready to burst 18 months ahead of time. Just look for massive growth over 5 years in any given market. a Seller's market for a long enough time leads to collapse. timing exactly when is the trick.

Re:A bit self-defeating

[BlackSabbath]

By and large, though, markets are unpredictable, and they need to stay that way. If markets were predictable, they would cease to exist... some one or a few would run off with all the money. To the extent that it has been "predictable" and made some corporations lots of money recently... as we have seen, that was largely due to manipulation and corruption, not the effects of free markets.

A few have run off with all the money. Who was on the other side of those massively leveraged positions that the banks lost on? It seems to me that the fact the losers are now being bailed out by the government means that effectively there has been a massive transfer of wealth from taxpayers to the "winners" of those bets.

Manipulated, corrupt and un-free markets indeed.

My suggestion to the submitter is to try a more honorable career, like record-company executive or drug-dealer.

Re:A bit self-defeating

[CompSciStud4U]

I would suggest reading The Black Swan. His basic thesis is that the gaussian methods used to calculate risk in financial markets underestimate the risk by several orders of magnitude. Crashes that happen every couple of decades are considered to be once in a million year occurrences by these methods. He made his money in the crash by betting against this. He assumes that he has no clue when a crash will happen, only that the risk is much greater than the vast majority of the market thinks. Everybody else thinks it will never happen, overextend themselves, and when the crash comes he takes their money. He did it in the 80's too.

Re:A bit self-defeating

[jstott]

No. His "system" is indeed based on the assumption that such events are unpredictable.

His system is basically arbitrage. We have an algorithm for pricing options (Black-Scholes) that makes an invalid assumption (it uses Gaussian statistics where it shouldn't). This fault was recognized almost as soon as it was published, but people continue to use it anyway, which means they're mis-pricing their options. Black Swan makes money in the long haul because they know big price swings occur more often than the options are priced for, and they buy based on this knowledge. Exploiting market mis-pricings like this one is the essence of arbitrage.

Like classic arbitrage, this only works because a) there is a mismatch between price and real cost [risk] and b) there aren't a lot of players making the same purchase. Change either A or B and Black Swan's strategy will become a money-loser, or at least a break-even.

-JS

I'm more interested in the governance than in math

[fuzzyfuzzyfungus]

As long as it is possible to get paid for the short term results of your crazy bets with other people's money, it barely matters whether the math actually works or not, you are fucked either way.

While I'm all for good mathematical modeling, the notion that our financial problems are caused by bad math is a distraction at best.

Quant != Finance Phd

[Sprogga]

There will always be a quant element in finance. I'd guess there will be fewer quants in five years than there were in (say) 2007, but there was definitely an over-supply then. Having said that, most quant jobs don't require you to have had specific training in finance or financial mathematics. For the best firms, its much more about your mathematical and programming abilities. So you definitely don't need to specialize now in finance to become a quant. You could make a case that focusing on AI would be a bigger draw with quant firms. The other advantage of not doing finance now is that it gives you five years to think about whether you want to be in a career where when you get down to it, you rent out your brain to rich people so that they can get richer. I do work as a quant and find it interesting and competitive etc, but ultimately its a money thaang.

The real problem with algorithmic trading...

[thesandbender]

I have worked with companies that implement and use "algorithmic" trading. The real problem is that algorithmic trading doesn't try to beat the market... it tries to beat other algorithmic traders. The idea is to get the trades in before anyone else and there is only so much analysis you can do in a given period of time. Honestly, there's no real analysis to it... it's snap judgments based off a few dozen indicators. It's the equivalent of saying you should guess all C's on standardized tests. On average it works... but you should be shooting for better than average.

Re:If you enjoy it ...

[Anonymous Coward]

As a former Wall Street trader turned academic, I can agree that the demand will continue to grow for financial mathematicians. The "old school" trader is a former ivy-league athlete who is good at networking and teamwork, but can't do a lick of math. The D.E. Shaw's and hedge funds are crushing the "old school" traders as trading becomes more about speed (esp. algorithmic trading) and liquidity and less about connections. The large banks still have plenty that follow the old mindset, but they are slowly being replaced by the more successful "quant" traders. Granted, the current crisis was caused by over-reliance on models, but that happened because most traders and managers did not understand the models and their limitations. To rectify that, there will be an even greater need for those trained in financial mathematics.

Mathematician Becomes Defense Secretary of the USA

[reporter]

If you love financial mathematics, then you should definitely study that subject. Do what you love. Life is short. Enjoy your time on earth.

Do not be concerned about "restricting" your future options. The applied mathematics in financial mathematics involves all areas of probability, random variables, and stochastic processes. These topics in applied mathematics have wide application in many diverse areas: digital image processing, gambling (e. g., card-counting techniques in the casinos of Las Vegas), computer simulations of warfare outcomes, etc. A degree in financial mathematics will enable you to work in many fields outside finance.

Mathematics, in general, does not restrict anyone's options -- if you are smart and hardworking. Just ask William Perry. He received graduate degrees in "only" mathematics and eventually became Secretary of Defense of the United States. His most recent accomplishment was authoring an essay published in "The Washington Post". In the essay, he advocates using military force to destroy North-Korean military facilities. Mr. Perry is a smart person with the right solution for dealing with North Korea.

Re:Mathematician Becomes Defense Secretary of the

[PopeRatzo]

Do what you love. Life is short. Enjoy your time on earth.

And for god's sake, smoke weed.

Everything is better with a bag of weed.

Re:Mathematician Becomes Defense Secretary of the

[martin-boundary]

WTF? How did you get from studying mathematics to nuking North Korea? That was beautiful old-skool trolling, man :)

I'd go further to say

[Sycraft-fu]

Don't go getting a masters or PhD if money is the objective. I see WAY too many people who are just hoop jumpers. They are going on to get a higher degree to get a better job. Some of these people get their PhD and then do post doc work not because there's still research they want to do but because they still can't get the job they want. Never occurs to them maybe education isn't the problem, it might be their complete lack of problem solving skills or the like.

A masters and more so PhD are NOT for everyone, they are not even for most people. They are supposed to be when you really want to specialize in an area and do new research on the topic. If that isn't what you are about, then don't go for it. Unless you are going in to a field that has a specific minimum, and most don't past a bachelors, then there's no reason to go for a higher degree just for its own sake.

Any time a friend or family member talks about wanting to get a masters my question for them is always: Why? Not as a petulant "Don't do it," thing but as a challenge. I want them to give me the reason they want to do it. If they can't, or the reason is "To make more money," then I'm going to tell them it is a bad idea. If the reason is "Because this interests and excites me," then I think it is a great idea, even if there isn't going to be a return on the money spent. Education for the sake of learning about what you want is wonderful. Just make sure that is really the reason you are doing it.

Re:I'd go further to say

[Lemmy Caution]

I don't completely agree with you. The BA or BS is the new high school diploma. To really optimize your earning potential, get an MA or MS. But yes, the PhD is actually good only if you love what you are working on more than you love the money it can earn you.