http://www.forbes.com/2008/10/07/securities-quants-models-oped-cx_ss_1008shreve_print.html
a little surprise nobody so far, but I don’t understand something in the article so really want to discuss with you guys, btw, Shreve is a big shot in Math Finance so I’m really interested in his article. He said: "It is easy under these circumstances to point an accusing finger at the “quants” on Wall Street, that cadre of mathematics and physics Ph.D.s who crunch numbers in esoteric models. Without the quants, the complicated mortgage-backed securities that fueled the housing bubble and led to the freezing of credit might not have been created. The models used by the quants determine the prices of those securities and steer the traders who make markets in them. Without this guidance, the banks might not have touched them in the first place. To prevent a recurrence of financial crises, some call for a return to a simpler time, before derivative securities and the quants who analyze them–a time when investors bought stocks and bonds and little else. Such complaints miss the point. When a bridge collapses, no one demands the abolition of civil engineering. One first determines if faulty engineering or shoddy construction caused the collapse. If engineering is to blame, the solution is better–not less–engineering. Furthermore, it would be preposterous to replace the bridge with a slower, less efficient ferry rather than to rebuild the bridge and overcome the obstacle. There are very good reasons for the existence of derivative securities–and even mortgage-backed securities, the root of our present problems. Potential homeowners need investors to fund their mortgages. So how can the two come together? The Savings and Loan system was a major provider of mortgages until its spectacular collapse in the 1980s, causing the Federal Deposit Insurance Corporation to require $120 billion from the U.S. Treasury to make depositors whole again. " The thing I’m not able to understand, is that why mortgage-backed securities is the only way to bridge the investors and homeowners? So a traditional bank does not do mortgage? And also, if a potential homeowner is rejected by a traditional bank because he is classified as high risk, then giving other investors a way to bet on the homeowner’s ability to repay the mortgage is really a good reason for the existence of MBS? So we don’t have enough casinos? He then said: “These instruments serve an economic purpose. Southwest Airlines recently reported its 69th consecutive quarterly profit, weathering two spikes in the price of jet fuel since 1991, because it used derivative securities to hedge against price increases. International firms use derivative securities to hedge currency risk. Insurance firms sell annuities that guarantee a lifetime income and must use derivative securities to hedge against increases in longevity. The quants did not create derivative securities. The quants help us understand them, price them, trade them and manage the risk associated with them.” I don’t understand again. Before the the existence of securities, we just need to expect the fuel price risk in the airline stock (or airline investment) itself. By using these derivatives, one can separate two risks so you can bet on each of them. So is it the economic values of the derivatives? And btw, what derivative is used to hedge against increases in longevity? “Before the collapse, Carnegie Mellon’s alumni in the industry were telling me that the level of complexity in the mortgage-backed securities market had exceeded the limitations of their models. The bridge was cantilevered out way too far, and the quants knew it. But in most banks, the quants are not the decision-makers. When they issue warnings that stand in the way of profits, they are quickly brushed aside. Furthermore, in addition to better engineering, the bridge must not be built this time with the shoddy construction material of no-documentation mortgage applications and a network of unscrupulous mortgage originators.” It sounds like he wanted to say the Carnegie Mellon’s alumni would have been the whistleblowers. but I think people need complicated product in order to earn big bucks, so they ask the quants to do the math. If they cant do, they’re fired. While the quants try to calculate the price accurate to 10e-6, people just don’t care 'cause as long as the product is so exotic that it’s the only one in the market, they can just multiple the calculated price by 2 or 3 and sell it out to the clients. And people hire quants just because they need somebody to blame in case of this kind of crap happens.
FIRST! … to long. didn’t read. to drunk… surprised we don’t have any posters like this on AF… i kid i kid… chad don’t ban me… rough day/month/year/2 years
smart ,charming young men have been promising to perform miracles with other people’s money since the dawn of time.