Thursday, March 12, 2009

So You Want To Be A Quant - Follow-Up

Physics Today blog covered this NY Times piece on Quants and their role (or non-role) in the current economic crisis. The blog had some rather interesting quotes:

Lee Smolin, a physicist at the Perimeter Institute for Theoretical Physics in Waterloo, Ontario, said, "What is amazing to me as I learn about this is how flimsy was the theoretical basis of the claims that derivatives and other complex financial instruments reduced risk, when their use in fact brought on instabilities."

Quants say that they should not be blamed for the actions of traders. They say they have been in the forefront of pointing out the shortcomings OF modern economics.

"I regard quants to be the good guys," said Eric R. Weinstein, a mathematical physicist who runs the Natron Group, a hedge fund in Manhattan. "We did try to warn people," he said. "This is a crisis caused by business decisions. This isn't the result of pointy-headed guys from fancy schools who didn't understand volatility or correlation."

Whether it is true or not hasn't changed my view of the field of finance and economics, which I do not consider to be a "science". It is more of an after-the-fact quantitative analysis with vague predictive power. That probably is an ignorant view of it, but I haven't heard, read, or seen enough evidence to the contrary.



Marcus Aurelius said...

I am with you that economics & finance are not sciences (much closer though than some things loosely labeled social sciences). Their key problem is the inability to apply the scientific method.

What nations would subject themselves to a series of tightly controlled experiments? None, so economic theorists have to rely on computer modeling as ways to test their ideas in a controlled fashion and we all know computer models have their limitations.

Still, economic & financial thought is often based on rigorous mathematics. Once a set of assumptions is set up the math can be done and answers can be obtained.

For instance, one in planning production to supply an event can apply economic principles and use those principles to plan production & set price points. Of course, a rainy day, could foil all of those plans and all of a sudden one's expected take is off.

Marcus Aurelius said...

As far as derivatives go.

Financial derivatives play a role in risk mitigation for professional money managers. Some years ago I was thinking of buying a foreign currency (going long the Filipino Peso) and part of the plan was to buy puts on the Peso - to hedge my bet against a drop in the Peson (with respect to the US Dollar). I never put the plan into action.

Problem is, speculators start getting in on the action - it is tempting to make a minimal investment with a potentially large payoff. However, if people are speculating by writing derivatives contracts instead of buying them they are bound to react a lot more strongly when market conditions reverse even the tiniest.

Captain Anarchy said...

This is interesting, and I very much agree with you. Pretending that something that is based on the subjective valuations of billions of people (the economy) is somehow not only victim to the same type of causative laws as physics, but calculable and predictable as well is being extremely naive.

You may be interested in Human Action by Ludwig von Mises, which proposes the use of a rationalist methodology in economics instead of a physics-like empiricist methodology. It's considered a "fringe branch" of econ, but given the failings of mainstream economics, it's easy to see why a different methodology is needed.

You can read it free here: