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Posted by on Mar 5, 2010 in Business, Markets, TG Roundup

QUANTum Screw

I am neither a mathematician, nor a programmer. However, my engineering education and experience has given me a fairly decent exposure to both. For whatever reason, the world of finance and economics always fascinated me. Back in 1995, when my job was a bit shaky, I contacted Mr. Rao Chalasani about switching my career. Rao was an economist at Everen Securities (later acquired by First Union Securities) and used to be quoted quite frequently in the financial press, including the Wall Street journal.  He explained to me about  the ‘quants’ and given my background how I might be a good fit there.

On his advise, for about two or three months, I tried to land a job as a quant a securities firm, however small it was. I then received a major award in my field and I had to ask myself if I should be in a field where I earned some recognition or leave to a discipline for the pure purpose of earning more money. I stuck to my field. So, whenever I see some news on ‘quants,’ I could see myself there in an alternative universe. In the blog that preceded TeluGlobe where I regularly posted, I posted the following article in Sept 2008.

Wednesday, September 24, 2008, 06:22 PM
Posted by Mohan Venigalla

I admit it. I was once a Wall Street “Quant” wannabe. A quant is somebody who uses extremely complicated math and devises formulae for financial derivatives products based on which traders do trading. For example, the Nobel Memorial Prize winning option pricing model by Black and Scholes (The Black-Scholes Model) is the most predominantly used model in pricing a variety of equity and futures derivatives such as call and put options.

There are underlying assumptions in each of these complex models, which are generally valid in a vast majority of situations. However, the assumptions do fail once in a while, and cause extreme dislocation in financial markets when these models are used to trade highly levered products controlling hundreds of billions of dollars. One example of this failure is Long Term Capital Management’s levered bets on arbitrage trades on assets worth $1.2 Trillion in 1998. The assumption that failed with LTCM and many Wall Street firms today is that for every trade there is a buyer and a seller. In tough markets, there comes a situation where there will be no buyers – just as in 1998 and just as now. We all heard that history repeats itself. But only in 10 years?

Do you know who was one of the founders and principals of now liquidated LTCM? Dr. Scholes. He co-developed the original option pricing model and received Nobel MEMORIAL Prize for Economics in 1997, just a few months before helping the World financial system to drop to its knees with his Prize winning model. Here (on left) is a funny profile of a typical quant [Source unknown.]

Fast forward to 2010. In his new book, “The Quants” Scott Patterson, has exposed the world of these math geeks who nearly destroyed the world with their voodoo math and unrealistic assumptions.

Get a load of this! The quants came up with Hippocratic oath, “I will remember that the I didn’t make the world and it doesn’t satisfy my equations.” They spoke with Scott Patterson for his book when everything was going great and talk no more now. Scott says that they refuse to accept any responsibility for their role in current crisis.

From what I am reading now, the quants are no longer into gambling in the mortgage-backed-securities casino. They have a new game in town. It is called “High Frequency Trading.” this time, they found a world which obeys their equations – with the help of the government, of course!

I don’t know about you, I am buying this book and reading it over my spring break. In the mean time, watch Jon’s interview with Scott Patterson. It is time well spent!

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Scott Patterson

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