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Archive for the ‘Finance and business’ Category

A quantitative biologist clueless about quants nonetheless muses about them

In Finance and business on May 14, 2009 at 12:41 am

An obligatory link to an article about quants, now the dust has settled a bit: Recipe for Disaster: The Formula That Killed Wall Street, in ways of a delayed follow-up to Sarah’s previous post.

Also, a slight update, and a past opinion piece.

And finally, another word from Wired The Plight of the Quants.

This phenomenon was something I was vaguely aware of—the serious study of economics is mathematics-heavy, and mathematics is a wonderfully translatable tool, so the fact that Wall Street started recruiting physicists and mathematicians doesn’t seem surprising, at least to an outsider. However, how does their skill set differ from that of pure mathematicians on one end and economists on the other? I’ve occasioned glances into the conceptual rifts between physicists and mathematicians (when Bill Bialek was lecturing for Integrated in my freshman year, he would often apologetically, but bemusedly, point out that particular approximations are anathema to purists—this turned out to be a recurrent theme throughout the first two years of Integrated).

This brings me to a second personal observation, and that is the parallel between quants’ emergent influence and the movement of physicists to biology in the last half century. Our biology departments (all two of them) are filled with those who want to use quantitative methods to study problems, whether it’s because they allow you to zoom in on areas of interest instead of searching an entire space, attach probabilities to certain models and hypotheses, generalize specific problems so that you can see a continuum of similar problems, predict outcomes., etc. Why was it that they wanted to study biological problems? Is it because life poses a different kind of challenge, just as unexplored and mysterious as our universe at large, and tickles their fancy for problems with deep-reaching consequences? Because living organisms are able to turn normal physical laws and properties on their head, rendering them seemingly paradoxical and unrecognizable, and therefore begging explanation? Because people gradually began to realize that biological problems can be described by the same differential equations that describe other physical phenomena? I say these things partially to poke fun at empty dreamers, partially because I suspect people are much more whimsical in their career choices than I expect them to be, and partially because, in all honesty, there is something to be said about choices that people often claim were random and whimsical. There were probably plenty of objective reasons behind biologists’ realization that they needed to turn to a different toolbox, but I wonder more about the psychology of those that were involved in the paradigm shift.

When I was at UPenn over the summer, I heard about a few string theorists (including the professor I worked for) who had turned 180° and started working on information theory in biological systems. This is entirely different from the streamlined university educations that we have today that try (with certain success) to churn out individuals who have quantitative biological backgrounds, and start work on biological problems from the get-go. These programs attract a different kind of people, so I wonder how quantitative biology’s culture will change in 10 years, if at all.

The interesting discrepancy between physicists’ induction into biology and the article’s description of quants’ role in financial institutions is strange to someone who’s so familiar with the day-to-day physics envy that pervades the natural sciences (I’m a molecular biology major), even if it is often self-referential and invoked humorously. Much of the anger directed at quants by traders, businesspeople, etc. just seems to be part of the economic blame game, rather than some existing historical rivalry, and the public’s anger is sure as hell one of those “Let’s torch the unknown” kind of gig. I’m sure that if the economy were doing fine, no one would even hear about quants, who would anonymously continue their financial research. It was pointed out by one of the interviewees in the primary Wired article that science isn’t about making money (nor is it about never making mistakes)—there is a pretty big difference between people who go into financial engineering from the get-go, and people who end up there because they liked math and ended up in applications.

And even then, being a college student, you see where adults get their start and you can manage to be a bit more forgiving. Sure, it makes you wonder how many random (and sometimes anguished) decisions ended up shaping our lives irreversibly (I’m reminded of a friend who swung over to English from astrophysics). It also reminds you of how immature people start out in a field, and then proceed to grow up, becoming empathetic and worldly—but stay with the occupation from a previous life’s choice. And yes, I am making the generous assumption that most people grow up. My point is that many people like making money, and it makes me feel uncomfortable when people who have been making an honest living have had their careers ridiculed and scorned by other questionably self-righteous adults just because they were unfortunate enough to be stuck in the 21st century with greedy management obsessed with short-term goals. I mean, how do you ever pinpoint the source of the problem? It’s easy to paint in broad strokes and act as if the cause was conveniently captured by a particular group of people in particular window in time. If there’s anything good that has come out of this at Princeton, it’s the heightened interest in charity work and taking time off before settling down with a job (according to a survey of the student body conducted by the student government, results available here). I don’t think it’s particularly great that all the future problem-solvers are scared, because it’s going to be difficult to solve an economic problem if all the young people are running in the opposite direction (if Wall Street is even interested in hiring anyone these days), but at the same time, forcing goal-oriented people to slow down and grow up a little more before taking on a full-time life commitment is not a bad thing at all.


Scientists need to keep their hats on in this political climate

In Finance and business, Policy on February 28, 2009 at 7:54 pm

A recent post by science writer John Tierney in the New York Times “Findings” column highlights Dr. Robert Pielke, Jr.’s book, The Honest Broker, which expresses a concern with scientists’ temptation to take advantage of their privileged position. Scientists in the company of non-scientists often overemphasize the credibility of their own models and speculations at the expense of politicians that don’t have the peer-reviewing ammunition that scientists do. Additionally, scientists who “enter the fray” find themselves having political debates, rather than scientific ones—Dr. Pielke wants the public, as well as the scientists, to recognize the distinction. The country is at a crucial juncture, and many will look to scientists for advice on investment options with regards to both the economy and climate change—in this light, the scrutiny is well-placed.

Although we shouldn’t jump the gun and become conspiracy theorists, it’s always prudent to revisit the important preface to critique of any science: scientists are human. It might seem like a trivial qualifier, but anyone who’s worked long enough in the sciences knows that they fight for credit, worry about their reputation, and navigate complex human networks like anyone else—most of us tend to forget this because we don’t often have the opportunity to share reflective conversations with science professors who have the honesty to look back their careers and laugh at themselves. I’m currently taking the course MOL 328 U.S. Medical Research and Researchers: Preeminence, Problems, Policies, and this post reminds me of the times that Prof. Rosenberg made polite remarks about arrogance and fiery temperaments (in reference to James Watson and Robert Gallo, respectively). Scientists’ personalities often make fascinating and amusing narratives, I assume because people so often take for granted the stereotype of scientists as disinterested, coldly intellectual fixtures that have better conversations with their computers and specimens than with other people. The strange juxtaposition of the objective reality we probe and our interpretation of it gives scientists this potentially awkward but uniquely endowed vantage point. Some make use of it, while others revel in their privacy and autonomy.

For those scientists (and academics in general) who have to defend their ideas in the public arena, debates that used to center on preliminary assumptions and gambles on plausible hypotheses are being transformed into debates that spill over from tiffs in academic journals to more personal political attacks in op-eds and press conferences. The emergence of the science blogosphere has made many scientists more accessible—by corollary, it has given contention a new place to thrive. The casual link between evolutionary theory and sociological and cultural history has encouraged people to interpret scientific results rather generously—while there are some who can thoughtfully articulate the interdisciplinary connections, it’s frightening how easily science and philosophy of science are confused.

The humanness of scientific research also introduces difficulties into collaborative projects that harbor potential for politicization. The relatively recent efforts in the last few decades to coordinate academia, government, and industry in the practice of medical research point to the impediments faced when groups with different goals and skill sets have to come to a consensus. The publication of the results of the Human Genome Project in two separate journals (Science and Nature) by two parties (at odds with one another over strategies for releasing the data), is one well-known example of the seeming irreconcilability of people’s (and scientists’) perspectives (reconciliation committees were unable to bridge the divide).

With this in mind, there are several problems with finding feasible environmental solutions that the government can pursue. For one, science advisers are inevitably going to have their own opinions on matters, and will steer funds and publicity how they see fit. I actually have very little idea how influential science advisers are, so if anyone would like to comment on this, please do. In any case, it’s problematic when scientists who’ve developed good tools and strategies are effectively ignored because the government has decided to back one public stance. Even if the government had a more multidimensional message to hash out, its inertia prevents it from reacting quickly enough to the innovations that periodically bubble up from scientists in academia and industry. Being a science major, I’m a bit lost on this one, because there are certainly times when the government primes the pump and energizes research in all sectors—what distinctions are there between the current environmental research movement and the booming medical research movement after WWII? The obvious factor is the economic fragility—post-war U.S. was the “last one standing,” but nowadays, we’re not even sure how many years it will take us to recover from the economic crisis. Even if we were to take into consideration the large wads of cash that are being handed to researchers as part of the astronomically large economic stimulus package, it’s a mystery to everyone whether stimulus money can actually be meaningfully utilized for research, which is a long-term endeavor. For more details on what the EPA plans to do with the money from the Recovery Act, look here. While it seems that the EPA is going to do a thorough clean-up job, there don’t seem to be any initiatives for creating technology for cleaner energy—something is missing the mark.

Not being an expert in policy, I am not surprised that the administration necessarily has to take a singular stance, but I am curious if there’s any way to make better use of the scientists who offer alternative (and often complementary) approaches to environmental problems. Is it a matter of freeing up regulation, federal funding, or large-scale implementation that makes the government’s role important in the furthering of these strategies, such as the air capture of carbon that Dr. Pielke feels is worth investing in? There is an incredibly palpable universal interest in environmental initiatives, but because of all the short-sighted projects and fire-lit hoops to jump through, we’re losing time while everyone lobbies for his own interests. The government lacks a systematic and diverse cooperative plan. Although the upcoming Power Shift Conference is certainly a step in the right direction, politicians’ willingness to establish effective clean energy policy has to start with a fair assessment of all the brands of environmental projects that are out there. Only then can young activists’ enthusiasm find a vehicle for realization. Tierney expresses a similar frustration when he writes, “Well, I suppose it never hurts to go on the record in opposition to a billion imaginary deaths. But I have a more immediate concern: Will Mr. Obama’s scientific counselors give him realistic plans for dealing with global warming and other threats?”

Stephen Colbert recently commented during his show (jokingly, but I suspect with some seriousness) on the parallel between the scare tactics of the Bush administration used to justify the Iraq War, and the apocalyptic grandeur of Democrats’ defense of the stimulus package. I think most people don’t care to be scared anymore–everyone knows there’s a lot at stake, even if you’re not sure what exactly the experts think it is. My feelings about expansive statements made by scientists seeking popular science sensationalism can be summed up by David Brooks’ worried remark in his recent New York Times op-ed column “The Uncertain Trumpet” on the many promises made in President Obama’s recent address: “Obama blew a mighty trumpet Tuesday night, but after you blow the trumpet, you actually have to charge.” Scientists can’t just capitalize on counting the ways that the world can end—they have a responsibility to bail us out when no one else knows how to. Along the way, the few pioneer scientist public figures are sure to blaze new trails, making the political machinery work for them, rather than working for the politics.

Stop Math Now!

In Finance and business, Math on February 25, 2009 at 4:47 am

Or so it would seem…
This article by Felix Salmon, pinpoints the Gaussian Copula formula, an advance in financial mathematics pioneered by David X. Li, as the source of our financial collapse.

With his brilliant spark of mathematical legerdemain, Li made it possible for traders to sell vast quantities of new securities, expanding financial markets to unimaginable levels.

His method was adopted by everybody from bond investors and Wall Street banks to ratings agencies and regulators. And it became so deeply entrenched—and was making people so much money—that warnings about its limitations were largely ignored.

Then the model fell apart. Cracks started appearing early on, when financial markets began behaving in ways that users of Li’s formula hadn’t expected. The cracks became full-fledged canyons in 2008—when ruptures in the financial system’s foundation swallowed up trillions of dollars and put the survival of the global banking system in serious peril.

So what is a copula? It’s a statistical model for determining correlation between different random distributions. Correlation is at the heart of the business of financial engineering — if you’re going to construct a CDO out of mortgage obligations, you’d better know the probability that all of them will default at once. Pricing risky assets — the problem the market got horribly wrong — rests on computing the correlation between rare events. Li’s formula had a deadly simplicity. Correlation was reduced to one parameter — it didn’t take into account the relationships between various loans that make up a pool. The correlation between two stocks may not be constant over time, but the copula formula treated it as if it were.

So is financial math evil? I’m inclined to think we need more of it, not less. A simple model was applied too enthusiastically by bankers who didn’t understand the quants — maybe we’d have been spared the current credit crisis if asset managers had more mathematical sophistication.

But read Salmon’s whole article; it’s very smart and very accessible.