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Paul Wilmott Wants To Retrain and Reform Wall Street's Quants
theodp writes "What if an aeronautics engineer couldn't reconcile his elegant design for a state-of-the-art jumbo jet with Newton's second law of motion and decided to tweak the equation to fit his design? In a way, Newsweek reports, this is what's happened in quantitative finance, which is in desperate need of reform. And 49-year-old Oxford-trained mathematician Paul Wilmott — arguably the most influential quant today — thinks he knows where to start. With his CQF program, Wilmott is out to save the quants from themselves and the rest of us from their future destruction. 'We need to get back to testing models rather than revering them,' says Wilmott. 'That's hard work, but this idea that there are these great principles governing finance and that correlations can just be plucked out of the air is totally false.'"
How about bringing their pay down in line with the pay of others (engineers and scientists) that do analysis of a similar level of difficulty? This is just a guess, but it would seem increased pay attracts people who want to make more money, not those that are genuinely interested in solving the problems in a field.
I'm a long way from New York, so someone correct me if I'm wrong[*], but I've always understood the problem to lie more with the people feeding data into the equations, rather than with the equations themselves.
Now, I accept that risk calculations consisted of a great deal of voodoo because, as Taleb tells us, they tended to ignore 'Black Swan' events (where the 1 in a million catastrophe wasn't going to happen just yet) and saw patterns where only chaos existed, but as I understand it, the core of the problem was simple greed: money-hungry mortgage and securities dealers deliberately feeding bad data into the system.
So-called quants may be decidedly imperfect, but if someone's willing to game the system to make a buck, nothing the quant does can stop it.
If Wilmott doesn't have an answer to that, I fear that his efforts will only obscure the real problem.
Crumb's Corollary: Never bring a knife to a bun fight.
...you always reach a point where there's this one number that is completely made up...
***Try a sensitivity analysis using Monte Carlo techniques. That sounds hard but it isn't. Take the parameter that you have doubts about and give it a distribution (Gaussian or rectangular or something) with the mean at your best guess and the std deviation chosen to be big enough to cover the range it might reasonably vary over.
***Use Gaussian if you have an idea of what the parameter probably is but aren't exactly sure, rectangular if you really have no idea. A rectangular distribution says "I have no idea, the parameter could be anywhere within this particular range."
***Then run your analysis a million times with the parameter selected randomly from it's distribution for each run.
***That gives you a stochastic dataset of results. You can run simple stats on that data set to find the mean and std dev of the result value. You will then know how sensitive your results are to your poorly understood input parameter. If your 2-sigma output tells you the expected rate of return on a particular investment varies between -50% to +50% then you will know your model is pretty much useless and you will be doing a better job than the vast majority of professional analysts.
****Monte Carlo is great for those of us who don't care to learn the arcane minutiae of stat math. If you have a working model it takes an hour or two to extend it so you get stochastic results. Note that it's no harder to give a distribution to all your input parameters not just one. In which case you will be doing the kind of work that people who make 500 grand a year do.
Equine Mammals Are Considerably Smaller
You mean being scientific about it? And strictly controlling the inputs so that it isn't just garbage in/garbage out? Crazy talk.
As it happens, I know a man who runs a fund that treats its models as disposable components that are expected to fail eventually. They're using genetic algorithms to create their models, and they let the models with the best record over the last six months make the buy/sell/hold decisions.
-jcr
The only title of honor that a tyrant can grant is "Enemy of the State."
The reason why we have economic problems is the same old one from the beginning of time -- good old fashioned human greed.
Agreed. But 50% of that problem is that people have absolutely no idea what money is. It makes taking it away from them dead simple.
Deleted
Mathematical models always only work in a certain range As Newtonian mechanics well for smaller velocities and macroscopic bodies it has to be replaced for large velocities or in smaller scales. Exponential growth laws have to be replaced by logistic growth. etc Models are especially popular in probability theory. The text mentions Gaussian Copula function, the "rocket fuel" for collateralized debt obligation, which is cited as one of the reasons for the finance disaster. See "The formula that killed Wall street".
It just cost us tens trillion dollars to figure out that 30 years of free trading investment oriented capitalism wrecks your manufacturing base, leaves your country hopelessly in debt, and all these so-called free enterprise guys bitching about the UAW making 40k a year are actually not so free enterprise after all, when it comes to bailing them out, or protecting their businesses.
This is my sig.
The reason why the quants ignore Black Swan events is that they are not financially impacted by them to any real extent. They make their living from making small amounts of money using lots and lots of leverage. But I prefer Buffett's metaphor for this sort of practice: picking up nickels in front of a bulldozer.
As long as "quants" can pick up "nickels" in front of a bulldozer for a few years, they can retire and never have to work again, even if their parent companies (and the companies they borrow from) go bankrupt. Those "nickels" are many millions, their percentage of those "nickels" are still high enough to retire on. Of course, they risk billions in the process.
I suspect the only way to really curb the practice would be to either limit amounts of leverage or cause complete bankruptcy/imprisonment/physical harm somehow to those responsible when the bulldozer (the black swan) eventually comes along. Of course, these laws can't really be applied to those responsible for the GFC. Laws can and probably will be created, and then after a few generations those laws will be repealed as the creation of a few old fuddy duddies who didn't understand whatever "new economy" comes along, and the cycle will repeat.
If I have seen further it is by stealing the Intellectual Property of giants.
Wall Street Is just Las Vegas with better clothes. All the day traders and other 'quick money" guys have rendered the idea of having an actual investment in a company because you believe they are going to do well in the future and desiring to be a part of that passe. They have also trained corporations to "damn everything but the quarterly reports!" causing long term damage and even failure to a company in return for short term profits.
We need to get the day traders out, and the investors back in. perhaps by setting up a tax than penalizes anyone who buys stocks for very quick turnovers and rewards those that hold onto a stock for a set period. Because real long term growth of a company takes investment. Investment and the building of infrastructure, training of employees, construction of new buildings, etc and all of these things cost. In the current Wall Street model such investments show up on the quarterly report and torpedo the stock. We should legalize gambling for those that want to take a shot at the quick cash and leave investing in the growth of businesses to investors that are willing to look at the long term picture, not simply the quarterly report.
ACs don't waste your time replying, your posts are never seen by me.
Trillion dollar bet now why did the world trade center get attacked, not once but twice...
Sure, you can do that. Blind Monte Carlo simulation sometimes catches reasonable behaviors and gives some glimpse into possible outcomes. But face it, using this kind of technique --- unless backed by a proven physical model, like molecular dynamics --- ***is*** a primary and definitive admission, no, confession, that you don't have ***any*** understanding of the underlying phenomena and that you've given up trying to do ***any*** science about them.
No offence.
Exactly! The situation in the economy, AIG, failing companies, the layoffs, outsourcing etc. is caused mostly if not entirely by corporate psychopaths which have a natural tendency to angle themselves into leadership position (they are very charismatic and manipulative) from which they can achieve the greatest benefit FOR THEMSELVES at the expense of others. Their total lack of "conscience" makes it so that any damage from their actions for them is unimportant. Even if it affects hundreds of millions of people. Even if the profit is tiny.
Check out Snakes in suits
In case you have not been suspecting something already, that is.
"The agriculture ministry is not in charge of Gundam" - Japanese ministry official.
You can say GM and Ford and Chrysler are going under to take down the UAW representing the rights of workers as a political force. Whether the UAW ceases existing, or the concessions it makes for the base it represents leave the base so financially strangled they become slaves to money and employers, slaves to necessity and no longer represent free will, unless suicidal, is irrelevant. The number of people as workers is always more than employers, and this represents an imbalance in society, concentration of power, which then leads to abuse, and abuse leads to retaliation and violence. A dominant middle class, or dominant equality in society, together with personal incentives present is the key to peace and nonviolence and overall human happiness. Middle class employees are a product of unions, they don't happen on their own. The natural behavior is the weak get weaker and the strong get stronger, the rich get richer and the poor get poorer, compound interest compounds to the extreme in either direction. Unless the many weak collectively gang up and stand up to the few strong. But then the danger is "falling off on the other side of the horse," where the union, the gang becomes too abusive, and blindly takes down the whole business enterprise, including the employer and themselves with it.
... for everyone, because there is too many of us, or there will be too many of us.
Another way is as a self sufficient yeoman farmer society, hailed by Thomas Jefferson and Isaac Newton. But these days farming is impossible because of low market price of food, and high cost of property taxes. In absence of high property taxes the yeoman farming society would be possible, but vulnerable to external attack because of insufficient defense funding. Also there is not enough land for everyone, as the Malthusian catastrophe hits. The population does not know how to practice self check and grows out of bounds without abusive control measures. In a sense abuse is a necessity to maintain balance. That is the most unfortunate thing of all as far as human happiness goes, and is the root cause of competition wars and suffering in the end, because there is not enough of
A massive scale small business based society where everyone is an employer is next to impossible to work out, because non farming individuals are not self sufficient because they are dependent on food. They can't say time-out and not participate for a few years as self sufficient yeoman farmers could, and retain their own free will, their free unbiased vote, because small business people have to purchase their own food and are therefore dependent on others, they are drawn into "Da game" by necessity to feed. Economy as a whole is vulnerable to the phenomenon of "economies of scale," and if you have to participate in "Da game" by necessity, you will lose out to those who are stronger, and we're back to the strong get stronger and weak get weaker, abuse and retaliation for abuse. If you're self sufficient, then you simply are not forced to participate in "Da game" and then "Da game" doesn't exist, because you can sell things for practically free too, and "economies of scale" can't abuse their power. I've always said "don't hate da playa, hate da game, bitch!"
So in the absence of self sufficient individuals in society - which is unworkable anyway because of Malthusian issues and defense funding reasons - the only way to ensure overall human happiness on a large scale is to ensure a dominant middle class through collective cooperation and bargaining, to have economies of scale institutions, and the participants - very few but very powerful individuals called employers to be in balance with the very many individuals but each having relatively little power, at the discussion table. If either the union or the employer get stronger, things go out of balance. If anything, the balance going out of whack by the employer getting stronger, we would have a dictatorship society with tremendous human suffering, but it's still sustainable, and things get
I think there is a misperception that quants just run wild with models with catastrophic results and that they are naive when it comes to practical matters. However, quants are also taught about "model risk" to include things like: wrong assumptions, poor estimation of parameters, errors in discretization, etc. Let's also not forget the positive social value of financial innovation. It helps you borrow at lower rates, pay less for insurance, etc. There were a few problems that led to this financial crisis and I think quants played a relatiely minor role.
EXACTLY...
I work in the financial world, and I do modeling, and I understand the quants because I do much of the same work that the quants do. Except I am an algo-trader.
The reality with all of this quant stuff is that it works until it doesn't. This is the crux of the problem and I would say a large part of the industry JUST DOES NOT GET IT... For example the comment to test models is hogwash. This financial engineering is not science. Its a scientific approach to madness of crowds. And the reality is that crowds can be mad and they will do irrational things that will just blow our minds.
Think about this, the Darwin awards gives awards to those humans that do REALLY stupid things. I for one am truly amazed, not at the stupidity, but at the shear creativity. I mean really, who on earth would think of that. And it is that creativity that blows up models, and blew up the entire financial market.
The models that the quants used worked until they did not. Sure there are many saying, "hey I told you so." Yeah whatever, humanity is stupid and will do stupid things because whenever we are told it can't be done, or should not be done we do it anyways.
In fact I think it is a good trait to have in humanity. Granted there are moments where we wish we did not have so many idiots.
Here is an example, George Bush and Iraq. I argued on the day of the invasion with a good friend of mine that it was stupid, idiotic for the exact reasons of why it is failing. I argued Sadam is a bad guy no doubt, but toppling Sadam will result in a quagmire. And I personally don't think it is worth it. My friend argued otherwise with weapons, etc, etc.
But, and here is the big but... WHAT IF it did work? What if everything worked out? It could have happened. What then? But you don't know that until you try it! For to try and fail is human! And nothing will ever avoid that...
"You can't make a race horse of a pig"
"No," said Samuel, "but you can make very fast pig"
All human decisions - even the most abstract or "rational" - have an emotional component; this has been experimentally measured.
Yes! I'm off-topic now but it is wonderful to see this assertion expressed on Slashdot. There's a tendency here to treat emotion as an uncomfortable byproduct of being a meat-sack.
In truth all the progress we have made is driven by emotion: we feel desire for some things (food, sex, Insightful moderations) and it gives us pleasure to try to figure other things out, which is really a desire for knowledge. We follow the creeds and models we do because we like them, and often the difference between philosophies comes down to which most emphasizes the parts of reality that each of us sees as being most important. This state of being engenders a lot of wrongheadedness--as current circumstances show--but without emotion we have no impetus to do anything at all.
Your brain is not a computer.