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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.'"
What a concept! Basing conclusions on experimental evidence from testing via trial and error rather than warping reality to fit your business model. That's incredible!
"I have never let my schooling interfere with my education." --Mark Twain
... getting back to the real economy? Many financial products don't add anything to the real economy at all.
Quants only produce models that act in the way that traders expect, and traders do not want bad news. I've done a small bit of modelling before and you always reach a point where there's this one number that is completely made up, and you kinda set things up so the trader makes the call. In this sense, all these models that everyone talks about are not so much as analysis tools as they are communications tools - you sorta code the insight of the trader as to how he or she thinks the market will move. It's a very human business, not one of a bunch of computers run amok. Quants that say otherwise are just full of themselves...
This is my sig.
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 know, this is just tinkering. It's a way of passing the buck. It's a way of devolving blame. It MUST be the equations, or the software, or some geek or some technological prblem that caused the economics failures.
It wasn't. It isn't.
The reason why we have economic problems is the same old one from the beginning of time -- good old fashioned human greed.
Equations, and new software isn't going to change that. What you need to do is ensure that the people operating systems and processes are ethical and honest. It's really that simple, and also, unfortunately, that difficult.
The problem with economics is that is probably more a sociological study than a idealized science.
Economics talks of supply and demand and perfect markets.
Yet we all know the advertising and social herd behavior affect purchases much more than any real needs or demands.
Nice idea, but Wilmot seems to have forgotten the most basic law of finance---nothing matters so long as you're making lots of money. Does he really think that the Quants on Wall Street and in London care about robust models and statistical significance? No! We're talking about used car salespersons in $5,000.00 suits. The financial industry is completely amoral. The only law is the law of the jungle. You can't confuse greed with a lack of quality control.
In another time, this would have been called what it is: theocracy, rule by theory.
Oh sure, they can try to be inductive, but there is always that old "correlation doesn't imply causation" gotcha isn't there?
The real solution to this problem with the social sciences was almost addressed by the Protestant culture that founded the US -- the Laboratory of the States -- but the incorporation of the slave states in the 1700s, with the resulting Amendment from Hell, the 14th, in the 1800s killed off that option entirely when "social science" sunk its fangs into the body politc in the 1900s.
"The Union" means everyone is a slave to the theocrats posing as theoreticians.
So now we're running uncontrolled experiments on nonconsenting human subjects in the guise of "public policy" of "liberal democracy" -- tyranny of the majority limited only by a vague laundry list of selectively enforced human rights.
Seastead this.
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.