Analysis_of_the_Quants_Book

The Quants: How a New Breed of Math Whizzes Conquered Wall Street and Nearly Destroyed It From the desk of an inspiring MBA student, the book is about the rise and fall of an extremely talented set of mathematicians and economists that came to dominate stock markets with quantitative modeling, sophisticated computer algorithms, and computer based trading. The book describes the type of Wall Street analyst called a “quant” as the math nerds who got straight A’s in school and applied advanced math techniques to try to discern patterns in stock prices and other investments. Patterson talks about the American success stories of driven men who were smart and hard working. How they happened to be in the right place, Wall Street, at the right time, late 1990's. I do not agree with the author's assertion that they almost destroyed Wall Street; they were an enabler of the high leverage stake that destroyed the stock market. In the book the “Quants,” the reader is introduced to the fascinating life and biography of five (5) Quants who demonstrated their love of mathematics and probabilities into billion dollar fortunes. Patterson's book does a good job of describing the drama and events behind the August, 2007 financial melt-down in the hedge fund business and how it toppled the banking business and ended in a dozen major bank bailouts. This book does a good job of putting a story behind some real life characters of Wall Street. You can’t help but admire their drive. However, one negative observation is the author continuously jumps from one biography to another. While he did it to illustrate what each was doing during a given period of time, I found it annoying and often would forget what which quant was last doing. The book was interesting because it took you into the secret world of hedge fund manager Jim Simons of Renaissance Technologies (RenTec). Not to mention, it also profiles Ken Griffin of Citadel Investment Group, Cliff Asness of AQR Capital, Peter Muller of Morgan Stanley's PDT (process driven trading) hedge fund, and Boaz Weinstein of Saba Capital (previously at Deutsche Bank). The Quants starts by focusing on Ed Thorp, a mathematics professor known for making money via beating blackjack with his book, Beat the Dealer. It then shifts to how Thorp went on to help pioneer the quant field on Wall Street with his convertible arbitrage strategy. The book describes the history and evolution of quantitative trading, framing things nicely before shifting focus to the financial crisis. The book describes how in 2006, these four men and their cohorts were the new kings of Wall Street. Muller, Griffin, Asness, and Weinstein were among the best and brightest of a new breed, the quants. Over the prior twenty years, this species of math whiz made billions not with gut calls or fundamental analysis but with formulas and high-speed computers. The quants believed that a cocktail of differential calculus, quantum physics, and advanced geometry held the key to reaping riches from the financial markets. And they helped create a digitized money-trading machine that could shift billions around the globe with the click of a mouse. Patterson then lays out comprehensive timeline of developments leading to the 2008 meltdown of the financial market, or at least the role that quant trading played in that debacle. Patterson traces the evolution of game theory as a foundation for trading from card counting at blackjack tables to high-volume black box trading driven by obscure heuristic algorithms. The later part of the book describes how some large hedge funds fared during the recent economic disaster. This section seemed to ramble to me: it went from one manager to the next, each one panicking and trying to figure out how to deal with their bad decisions. The book doesn't really get much into the deeper causes of the problems, and I couldn't care much about incompetent riches doing their job poorly. Greedy CEOs, bad regulators, short sellers, debt-happy Americans, and politicians of all stripes have been blamed for the great credit crisis of 2008. Until recently, all parties seemed to benefit from the boom, particularly the major financial players in the rich economies, while the risks were conveniently ignored, despite repeated warnings. Prior to the Wall Street’s collapse, where were those supposedly financial whizzes who designed the complex investment products that created the sub-prime mortgage and subsequent financial chaos' These products are the result, which included complex securities and derivatives tied to the value of mortgage debt and the risk of credit defaults. However, this were the result of years of research and modeling undertaken by a group of math and physics PhD's (many from MIT and the University of Chicago) who came to Wall Street in growing numbers over the last two decades. They were lured not only by big money, but also the challenge of uncovering grand theories of finance economics by the elegant precepts found in physics and math. Patterson noted in the book that the model that Greenspan referred to was the belief that financial markets and economies are self-correcting, which ties to the “invisible hand” in which prices guide resources toward the most efficient outcome through the laws of supply and demand. “Greenspan also believed economic agents acting on their own self-interest create the best of all possible worlds, as it were guiding them to the truth. And the efficient market machine the quants put their faith in. Government rule only hinder this process. However, Greenspan for years advocated an aggressive policy of deregulation before this very same congressman in speech after speech. Investment banks hedge funds, the derivatives industry are the core elements of the banking system. Greenspan believed if left along, he believed, would create a more efficient and cost efficient financial system.” Greenspan was wrong there were a flaw in the system which resulted in the meltdown. When the SEC issues a snap ban on short-selling financial stocks, or the Treasury Department decides to allow an enormous investment bank to fail, while throwing a lifeline to other major financial institutions, there is simply no way for quantitative models to "understand" such rare and unpredictable events. Funny thing happened in 2007 and 2008. The algorithms and computer models failed to factor in the market's human, emotional element. In the awake of any financial collapse we need some type of code of conduct for quants available. Patterson writes that there is no single truth in the chaotic world of finance, where panics, manias, and chaotic behavior can overwhelm all expectations of rationality. The quants focused mainly on figures like the expected returns and the default risk of financial instruments. What they didn’t sufficiently take into account was human behavior, specifically the potential for widespread panic. Patterson observed that models designed on the premise that the market is predictable and rational are doomed to fail. Which resulted in a lot of investors got too scared to buy or sell, markets seized up and the models failed. They failed to recognized and realize that hundreds of billions of highly leveraged dollars are riding on those models, catastrophe is looming. So we do need models and mathematics because you cannot think about finance or economics without them. However, we must never forget that models are not the world. We must start with models and then overlay them with common sense and experience. Now, amid the wreckage of Wall Street, the quants, once practically worshiped as the smartest minds on Wall Street, have become viewed in the public eye as poster children that ruined people’s life worth. What we do know, “Good or bad, moral or immoral, people are going to make markets and trade via computers, but hopefully not at the stake of another meltdown. The book ends with a note on dark pools, an off-regulatory limit exchange which almost every fund manager uses it in US. Quite contrary to the title of the book which hints to a casual onlooker that, Quant is on a decline, the book ends with this statement. Indeed, Patterson's grim conclusion suggests that perhaps the recent stock market collapse of 2007-2008 is not so much the end of "the quants," as he calls them. Or perhaps it only signals of a new breed of quants that may soon come to dominate Wall Street once again, and bring with them new potential for catastrophic failure of the markets. One thing I'm taking away from this is that it's scary to know and think there is no system to protect against another huge failure. In the end the truth wasn’t about whether the market was efficient or in equilibrium. The truth was very simple and remorseless as the driving force of any cut throat Wall Street banker; did you make any money, or not' Nothing else mattered; just beware of geeks bearing formulas.