Tuesday, May 12, 2015

Review of My Life as a Quant: Reflections on Physics and Finance by Emanuel Derman

Emanuel Derman is "one of the first high-energy particle physicists to migrate to Wall Street" who wrote My Life as a Quant in 2007, right before the major setback in "techno-autistic" investing.

Derman got into physics too late, at the point where even a brilliant person didn't have much chance of extending the science in a significant way. So, he went to work for investment bank trading operations which needed the computer and modeling skills that the scientists (who had been overproduced) could offer.

About the closest that Derman came to greatness is that he worked for Fischer Black. But the people that he and Fischer worked for at investment banks - who worked with people (or money) rather than software - made much more money.

The book gives a little sketch of how a market gets more efficient through competition. Here is a good observation he made:

"[T]he model for a bond option must differ from that of the classic Black-Scholes model. But this is a subtlety - when a new product is first created, a crude Black-Scholes-like model often suffices. Then, an arms race begins. As competitive pressures increase and spreads tighten, quants at different firms refine and extend their first pass at the model, adding new and more accurate descriptions... Extending the model demands a grasp of financial theory, mathematics, and computing, and quants work at the intersection of those three disciplines."
He misses the chance to generalize this though, and examine how profitable trading opportunities go through a lifecycle where the innovation diffuses and they become commodities. As I've been saying: no evergreen investment strategies.

Derman agrees with something I've often said about the bond market being smarter than the equity market:
"Fixed-income trading requires a better grasp of technology and quantitative methods than equities trading. A trader friend of mine summed it up succinctly when, after I commented to him that the fixed-income traders I knew seemed smarter than the equity traders, he replied that 'that's because there's no competitive edge to being smart in the equities business.'"
I wouldn't hire this guy to manage my money. Pretty amazing how younger, hungrier people can displace you in investing. (The "new school" concept.) Accumulated capital and contacts are advantages, but age isn't. Accumulated knowledge is probably a huge advantage in value investing, but only if it has led to wisdom and patience.


1 comment:

CP said...

See also: