Quants: Goths of the Financial World

A great 2-part article about the math freaks behind much of Wall Street's automated trading (and the summer meltdown they caused) can be found in MIT's Technology Review magazine (Part I, Part II).  The feature is called The Blow-Up, and I hope the links from TR's email newsletter work here.  Some of the smartest math minds in the world have been analyzing the mathematics and patterns behind financial markets, attempting to crack their codes and exploit them for maximum gain.  No news there, and nothing wrong with that - well, almost nothing.  The thing is, the systems that they are creating are so complex and far-reaching, resulting in unforeseen and unintended "linkages" and consequences on a scale beyond any of their comprehension, that I am reminded of Rome's employment of various barbarian tribes for the purposes of dealing with situations that they themselves were no longer capable of dealing with, while using methods and techniques that the Romans themselves didn't fully grasp or comprehend.  The mentality was "as long as the job's getting done, we don't care how, and we really don't mind all that much if we don't understand exactly how the job is accomplished."
As we all know, this ended...badly, shall we say, for the Romans.  Events continued to spiral out of their control, and eventually out of the control of the very barbarians who were entrusted with the security of the empire.  They had created a monster in pursuit of more, more, and still more, and the monster devoured them.  As far as I can tell, Wall Street has been doing the same thing for a couple of decades now.  Computers were enlisted to get a handle on things, along with computer programmers; then, some real wizards were brought in to get an edge, touching off an arms race; then everyone had armies of wizards, and they started going for even more fantastic minds and ideas (or schemes, if you will), and now, when asked about their techniques of using math and only math to evaluate investment decisions for hedge funds, these wizards are saying things like "If you think you can find out what you need to know by going to see the management of a company, then I have nothing to say to you."
Here's the bottom line.  Only the smartest of the smart can figure out what these quants have figured out.  And they are likely to only understand what they have personally figured out, rather than being able to understand what every other smart person has modeled and programmed.  They are using math and only math to base their investing decisions on, so business management and product design and other non-numerical data factors are not brought into consideration, apart from how they impact financial operating results (which is, admittedly, very relevant to why they look at the numbers they look at).  And let's not forget about the mind-boggling leverage that they are employing through derivative creation and manipulation.  This results in higher than expected returns when they get it right; it also results in larger and faster than expected tumbles in the markets when "outliers" inevitably manifest themselves.
The largest, ugliest, most damaging and even dangerous market calamities over the past 20 years have been caused and/or exacerbated by automated computer trading, and on that point there can be no disagreement.  All in the name of bigger and faster returns, nothing more.  This fact needs to be recognized and dealt with, taking measures such as increasing margin requirements for computer-based trading (or eliminating margin trading altogether for these billion-dollar systems), before the Goths known as "quants" ravage the empire beyond all repair, largely to satisfy intellectual arrogance evidenced by their failure to acknowledge that they do not and cannot know all of the implications and ramifications of the all-powerful trading systems that they construct and unleash up the financial world on a daily basis.  Their very invention and use of the word "outlier" implies their true feelings, which are that it's the fault of something that "shouldn't happen," or a "hundred year event," or systemic problems being termed "cascading failures" when out-of-control chain reactions like those feared by the first nuclear physicists take place- all to give the impression that they know exactly what should and will happen at all times and in all scenarios, when in fact, what they SHOULD be saying is "we have no idea about what this might affect, how catastrophic the results will be, or how soon they will occur; all we know for sure is that this isn't the first screw up nor the last, it's bad but it can be much worse, and if you give us enough time and resources, eventually we'll blow this whole thing up beyond anyone's recognition.  But hey, we'll sure be living the life until that nasty day, won't we?"

Comments

[Shefaly]

Worth: Yes, I read them the same day. I read a lot of stuff myself so I find it harder and harder to recommended reads but I try :-)

I think some book communities exist. There is one where you apparently set the book "free" and then they trace it by a code. To see where it got to. And as you can guess, yep, cannot remember. Why? Because I never give my books to anyone.. :-/

The trouble is that sticker shock - if money is involved - comes from shipping costs which factor in time as well.

If there is nothing existing, why don't you start one? I am sure Shelfari or Amazon would like the idea. More Shelfari than Amazon actually I think.

BTW about 15% of my bookshelf is on Shelfari - different handle. Link on blog sidebar.