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发信人: findle (It is not a big deal), 信区: Quant
标 题: Don't Blame The Quant -- Steven Shreve (zz)
发信站: BBS 未名空间站 (Fri Oct 10 13:47:19 2008), 转信
http://www.forbes.com/opinions/2008/10/07/securities-quants-models-oped-cx_ss_1008shreve.html
Don't Blame The Quants
Steven Shreve 10.08.08, 12:01 AM ET
Financial markets are a mess, and the excesses of the finance industry are
dragging down the whole economy. In recent years, safe investments delivered
unusually low returns, and hordes of investors seeking to be above average
(as Garrison Keillor would say) bought extremely complicated instruments.
The investment banks created such instruments, so-called mortgage-backed
securities, with payoffs that depend on the performance of hundreds or even
thousands of mortgages. Many of these securities received investment-grade
ratings, and their returns were significantly greater than investing in a
comparably rated bond. The law that higher risk means higher expected return
seemed to have been repealed. The practice of "ratings arbitrage," getting
a better-than-merited rating and selling securities based on that rating,
was born.
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.
Today, foreign institutions have the big money--and they would not make
deposits in U.S. Savings and Loans even if such institutions were available.
Energy trading did not disappear with the demise of Enron, and neither will
mortgage-backed securities after this fiasco. Put simply, the bridge
between lenders and borrowers will be rebuilt, because we need it. It should
, however, be built with better engineering and greater simplicity than
before.
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.
Regardless of what some may wish, we will not revert to a simpler time
before derivative securities; that simpler time never existed. Options have
been traded since the 17th century--and even before that, in ancient times,
by some accounts.
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.
The quants know better than anyone how their models can fail. For banks, the
only way to avoid a repetition of the current crisis is to measure and
control all their risks, including the risk that their models give incorrect
results. On the other hand, the surest way to repeat this disaster is to
trust the models blindly while taking large-scale advantage of situations
where they seem to provide trading strategies that would yield results too
good to be true. Because this bridge will be rebuilt, the way out of our
present dilemma is not to blame the quants. We must instead hire good ones--
and listen to them.
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