I had been reading black swan few months ago and admittedly from a very different angle. While there were numerous references to the stock market crash, hardly did I realise that the dig is at the stock market wiz kids and their quantitative analytics and prediction. This book, written by Wall Street journalist Scott Patterson, indeed gave me the clue on what Taleb was hinting at. He was questioning the ability of these people to predict the stock market future, comparing them with the intelligence of taxi driver.
Scott Pattesons book , The Quants, looks at this phenomenon that controlled the stock market during the last few decades. The influx of mathematical and physics wizards entering the arena of trading using complicated algorithm written on super powered computers , making huge profits out of the system, which traditionally relied on the intuition ( to an extend) and limited knowledge of the traders. Scott looks at the tribe in general starting from few trend setters in early days and four wiz-kids in particular ( Morgan Stanley’s Peter Muller, Citadel hedge fund’s Ken Griffin, Cliff Asness of AQR hedge fund, and Boaz Weinstein of Deutsche Bank ).
Their traits are common. High education with PhDs in mathematics or Physics, Excellent computer skills , the ability to use data and analytics to predict the movement of stocks, derivatives or bonds, a quick eye to spot anomalies in the trading system , and to sum it all the thill of beating the system. Most of them started their early days with some thing in common. Curiosity over gambling..the ability to predict Russian Roulettes ( buying a second hand machine to do their research), the black jack table or winning the poker table ( Interestingly Poker become one of their favourite pass time , often spending the entire night among themselves trying to out win the rest. All of them belong to the top 50-100 poker professionals in the world). Some of these had the reputation of being in the watch list of Casinos around the world, for their ability to beat the system regularly. Their hypothesis is interesting and are extremely complex to the common brain. The explosion of internet and the computers and IT had definitely helped them to rule the market for a long time.
It was sort of natural progression that these ended up at the largest gambling arena of the world, the financial market. It took no time, for them to figure out the ways and means of beating the system ( most of them were inspired by the book 'Beat the market" by one of the earlier quants Ed Thorpe). Scott also examines various techniques and principles that become popular over the years for the bankers and those dealing with hedge funds. The Quants weren't welcomed by the traditional traders enthusiastically. those experience of a life time is being questioned by few twenty something, who has no prior knowledge of the system. "You don't know a shit about trading, boy" were the typical reaction. But it took very less time for things to change. These 'inexperienced lads in jeans and T-shirts' started popping large amount of profits for their employers. They were the pets of the bankers often raising billions of money through their hedge funds, constantly beating the market both in good as well as bad times.
While this continued for a long time, there was always a doubt on its capability to extend this to eternity.
"Despite Success, it always seemed ephemeral, as if one day the magic would go away, vanish like a genie into its bottle. As if one day the Truth wouldn't be the Truth anymore."
The traditional big-wigs, like Warren Buffet and others stayed out of this , relying on the traditional means. There are others like Nassim Nicolass Taleb , who himself was a quant ( so to say) , was critical to their approach and was questioning them , often into heated arguments with them.
"Taleb had gained the reputation as a gadfly of the quants, constantly questioning their ability to beat the market. Taleb did not believe in the Truth. He certainly didn't believe it could be quantified."
The later events shows that Taleb had the last laugh. The unprecedented growth had to come down and the final fall of the quantdom was the sub-prime crisis, collapsing the financial systems of the world during Aug 2007.
Scott Patterson writes this book like a thriller. There is no dull moment in reading. While I am not an expert in the subject of the book, as an outsider, I understand a bit better of the important part these mathematical and analytical tools played in the financial market and I believe that it is likely to stay that way ( may be with great sophistication). The book had its own flows, there are undue glorification, the fiction-style of writing of a more journalistic nature of subject and some of the facts which I find difficult to appreciate.
Wall Street Journal