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Last Updated: Monday, 26 November 2007, 13:26 GMT
Mathematicians' role in market mayhem
By Innes Bowen
Series Producer, More or Less, BBC Radio 4

William Hooper
William Hooper designs mathematical trading models

The financial markets are increasingly dominated by a new breed of highly mathematical traders, known as quantitative analysts or "quants".

Whilst some celebrate the fact that empirical techniques are now applied to trading, others blame the quants for the current credit squeeze.

Even on More or Less, BBC Radio 4's weekly excursion into the world of numbers, we are prepared to admit that the image of the mathematician is not a particularly glamorous one.

So when we managed to penetrate the secretive world of super-rich financial mathematicians known as "quants" we saw the chance to challenge popular perception.

Model trader

Hedge funds and banks now offer talented mathematicians the chance to earn the sort of money more usually associated with top professional footballers and rock stars.

"My model is one of those which prints money," says maths graduate William Hooper from the comfort of his luxury home in Hampstead, one of London's most desirable suburbs.

The mathematical model he has designed to trade currencies does not of course literally print money but it has made huge sums for both him and the bank where he works.
We just require people to be clever and obsessively interested in research
David Harding, Winton Capital Management

He will not reveal exactly how much he earns but he says that so-called algorithmic traders are usually paid about 20% of the money their model makes and the typical algorithmic trader will make his employer about US $10-20 million a year.

Those prepared to take bigger risks, he says, can make billions.

His website shows him enjoying the high life in the company of beautiful girlfriends.

He says he enjoys spending his money on hi tech gadgets, art and champagne and, as his model does all the trading, he has plenty of time to work out in the gym and to go on adventure holidays.

"It's a nice way to trade," he says.

Social skills

William almost goes out of his way to confound the traditional stereotype of the shy genius who is more comfortable working out complicated algorithms than interacting with fellow human beings.

According to recruitment consultant Matthew Hall, having the social skills to communicate with less numerate colleagues is essential for those who want to get a job as a quant in a bank.
An analyst looks at his screen
Some say quantative analysts are to blame for the credit crunch

But there is also a market for the intellectual recluse. Many of the quant hedge funds are looking for raw intelligence and little else.

When I telephoned one fund to ask if we could interview some of their quants, the receptionist told me that I was unlikely to get permission, partly because of the secretive, commercially sensitive nature of their work but also, because many of them in that fund are autistic.

David Harding, who heads London-based hedge fund Winton Capital Management, recruits top mathematicians from all over the world.

"In today's world there's a good market for social skills. We do not necessarily require that," he says.

"We just require people to be clever and obsessively interested in research."

Opaque instruments

Since this summer's liquidity crisis however the quants have found themselves being criticised for more than just a lack of social skills. Some blame them for the crisis itself.

The quants have been crucial to the creation of increasingly complex financial instruments that are so opaque that few people really understand them.
The idea that computer programmes are the biggest force in the market is unnerving to some people
Paul Kedrosky, US hedge fund director

Their critics cite the so-called Collateralised Debt Obligations (CDOs) based on sub-prime mortgages as an example of the sort of fiendishly complicated financial instrument that carries more risk than investors realise.

Furthermore, the quants, so the theory goes, have all been relying on the same models so, when one fund wants to divest itself of a particular type of asset, many other funds will have decided simultaneously to do the same thing.

When the quants' models lose money, the banks have little left to lend to the rest of us.

This has become a popular explanation of how the current liquidity crisis came about. It even formed the basis of a recent sketch by the British television comedians John Bird and John Fortune.

But is it fair?

According to Professor William Perraudin, Chair of Finance at Imperial College London's Tanaka Business School:

"The quants are a fairly innocent part of all this. It is the senior people who make decisions about taking on risk who bear the responsibility."

Quant bashing

US hedge fund director Paul Kedrosky thinks that quant bashing has gone too far. "Turning an important and multi-faceted story into The Attack of the Killer Quants! is shallow and unhelpful," he told readers of his financial blog Infectious Greed.
Boarded up house in Cleveland Ohio
Defaults in the US housing market triggered the credit crunch

He feels much of the criticism is fear based on ignorance.

"To people who were raised on the idea that stocks were something you diligently researched by reading the Financial Times and the Wall Street journal then buy a little, this is scary stuff," Mr Kedrosky says.

"The idea that computer programmes are the biggest force in the market is unnerving to some people."

However, one well-known quant thinks that there are good reasons to apportion at least part of the blame to the financial mathematicians.

Paul Wilmott is someone with privileged access to the usually secretive world of the quants.

He runs a website where quants discuss mathematical problems and can watch lectures on quantitative finance 24 hours a day. He talks regularly to those working in a wide range of banks and hedge funds.

He believes the accusation that many banks use the same models is true: "The way in which quants are compensated encourages them to use the same strategies as everyone else."

He claims that many quants calculate that if they lose money as a result of following a novel strategy they will be fired.

However, if they lose money as a result of following the same strategy as everyone else, they will not get the blame.

"The problem with this," says Mr Wilmott, "is that if something bad happens, it happens across the board."

Consumer benefits

Another problem, according to Mr Wilmott, is that academically trained mathematicians are more used to modelling sound physical principles than difficult-to-predict financial markets:

"With finance you are essentially modelling human beings which is much more tricky."

The use of mathematical models may be risky but getting rid of the quants would be a mistake according to Professor Perraudin.

Ordinary consumers, he says, have benefited from the quants' inventiveness: "The quants have enabled financial institutions to behave in a super efficient way, committing as little capital as possible to their activities."

This has allowed relatively small competitors to take on the larger institutions in the provision of financial services and led, in turn, to cheaper loans.

"If we returned to old fashioned ways of trading," he warns, "the terms of borrowing would be far worse."

More or Less is presented by Tim Harford of the Financial Times, author of the Undercover Economist. It is broadcast on Radio 4 at 4.30 pm on Mondays.



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