The Quants: How a New Breed of Math Whizzes Conquered Wall Street and Nearly Destroyed It
By Scott Patterson
Crown Business, 2009, 352 pages
In The Quants, Scott Patterson, a staff reporter for the Wall Street Journal who covers technology in the financial markets, explores the most significant development on his beat over the last decade, the rise of the so-called quants: quantitative analysts, advisors, and investors using fast computers and sophisticated mathematics to ferret out money-making opportunities and make fortunes for themselves and their masters.
To tell the tale, Patterson weaves together the stories of nine people, whose roles range from godfather of the quant movement (Ed Thorp) to fabulously wealthy practitioners (Cliff Asness, Ken Griffin, and Boaz Weinstein, among others) to quant critics (British finance guru Paul Wilmott and polymath scientist Benoit Mandelbrot). Other characters, including Nassim Nicholas Taleb of “black swan” fame, flit in and out, while in the background is the constant presence of Eugene Fama, the University of Chicago’s star finance professor, and his brainchild, the efficient market hypothesis (EMH).
The EMH contends that at any moment in time the prices of financial securities traded in public markets are an unbiased reflection of the opinions of knowledgeable investors, and thus it is impossible to make excess profits. It is a sophisticated version of the old joke about the economist who refuses to reach for a $20 bill that is lying in the street because “if it were really there, someone would have picked it up already.”
This compelling theory, with its elegant mathematical underpinnings, appears to have had widely divergent effects on those exposed to it. For would-be investors, the EMH acted as an amphetamine, supplying both a challenge and the analytical tools with which to beat the market, provided that they were really, really smart and had very fast computers. For the regulators of security markets, it acted as a depressant, lulling them into the belief that markets were self-correcting and little control was required.
There was nothing wrong with this, as long as the variations in the pricing of financial instruments followed the statistical distributions of the Gaussian, or normal, curve. That’s where Mandelbrot enters the story, with his long-standing contention that security price variations do not follow such normal distributions, but instead resemble the “fat-tailed” curves described by French mathematician Paul Pierre Lévy, in which extreme events were much more likely to happen than predicted by the EMH. For a long time, like a Greek chorus, Mandelbrot and those who agreed with him prophesied catastrophe but were ignored. Their views have now been vindicated.
Patterson has written a highly readable book with fascinating insights into the strange quant subculture. Unfortunately, most of the players generate little empathy; their wonkish preoccupations seem to allow scant space for community and societal concerns. It doesn’t help, of course, that they have also made pots of money at the expense of the average investor and taxpayer. Sometime in the future, we may look back and marvel at a society that so richly rewarded some of its best minds to labor with such powerful means toward such narrow ends.permalink.