The guys at Minyanville, a group of very smart investors and hedge fund managers, did a Q&A and video with me. We talk about what’s wrong with some quant techniques, a little Black Monday, a little LTCM, fat tails, Ed Thorp (an example of what’s right)–and more.
Hi to Mr. Patterson
Just finished reading the Quants. You talk about Wall Street Banks’ voracious appetite for the subprime mortgage CDOs, but do not mention that it was our Congress that started the whole trend. Why leave the blame with Wall Street?
title=” Modelling 101″>
Scott, just finished your book; Quants. I want to say that you missed a big problem and much the reason why those geeks got into trouble: they forgot their models were based on the “old” market without CDOs credit swaps etc. When they changed the market with new instruments but used an old model based on a market without them they were acting irrationally to believe that the models were working. That’s the probelm with young jocks…they think they are invincible and don’t have the judgment of age to temper their behavior…thus why the fed must be involved OR people like Thorp have to do a better job educating them about the faults in models. True they didn’t program in the wide swings…probalby because that’s much harder to do unless you use simulation models with the appropriate population description. Been reading Mandelbrott’s books for years. He had a way to do that but they of course ignored him.
Years ago I took a data mining class. Intense week long class with a quant jock who was reallly annoying. He showed us HIS financial model. He said it did great in a Bull market but when things went south it failed. I asked him what data he used to develop the market. The time period he used was duruing a bull market. Quelle surprise…it didn’t work when the market went bear. He couldnt’ understand it. I didn’t even bother to explain. I was taking CLASS from him??
Your quant geeks reminded me of being in international finance with the SMU MBAs. I was getting a Doctorate Engineering Management degree at the time and just left the corporate world of mfg. These kids (I was 28) would ARGUE with me about how one should do things wiht NO experience in the real world. They could not understand.
One day, the finance professor posited a system whereby you could make endless cash on the stock market. He asked who was in with him? Nearly all the young jocks raised their hand. I stood up and said “I don’t believe in perpetual motion and basically that’s what you are proposing, so no I”m not in.” The guys around me started arguing but the professor (raising my esteem for him slightly) stopped them by saying I was correct. They could not figure out how it could fail. In effect they conned themselves into believing, because they did not understand how business works.
The geeks from physics etc didn’t either. BUT they should have known that when the market changed with completly NEW instruments that their models were no longer relevant. It just took a while to show up and cost us all dearly. They may be smart, but they are stupidly smart..much like those MBAs at SMU. Smug and self important they care nothing for others. The geeks caught the same fever.