Crude And Approximate But Often Useful

Emanuel Derman, a well-known ‘quant’ (quantitative analyst) and ex-theoretical physicist, has written a couple of very interesting posts (Part 1, Part 2) on the skills and mindset required for a successful career in ‘financial engineering’. This multidisciplinary field has been defined as ‘the application of science-based mathematical models to decisions about saving, investing, borrowing, lending, and managing risk’.

Here are some excerpts from the posts:

On model building:

The methodology of quantitative finance is different from large parts of physics or chemistry or even biology. Financial models are crude, and are mostly analogies. They say something like “it may be useful to think that people value bonds by discounting them over the paths of all future short-term interest rates.” This isn’t true, but it’s just possibly useful. In contrast, in physics you can say that the quantum mechanical world behaves as though a particle really does take all future paths to its target, with interfering probabilities. This isn’t merely useful, it’s actually true.

So, if you work as a practitioner, you will have to live with the fact that you are going to have to make crude, false but hopefully useful approximations.

On knowledge sharing:

If you’re a scientist by training or nature, you will have to tolerate the anti-academic attitude of many people in the business world, though that is changing too. Are you comfortable with the idea that research should be kept secret, because that’s what many people on the Street believe, even if the secrets they think they know were sometimes borrowed from someone else, are not really that secret much of the time, and perhaps are rarely worth being kept secret?

And on values and purpose:

Personally, I like to think that to do quantitative finance you need to be committed to clarity – that there’s value in the world to seeing anything clearly and understanding it honestly, to seeing the world the way it really is. That’s enough of a vocation — to understand some part of the world. To be a good practitioner I like to think you need a dedication to unsentimental truth about whatever you deal with, wherever it may take you.

In a similar vein, he’s got an interesting-sounding book coming out this month: ‘Models.Behaving.Badly: Why Confusing Illusion with Reality Can Lead to Disaster, on Wall Street and in Life’.

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