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“Quant” is an elastic word that has meant different things at different times. Historically, the term referred to back-room technicians who used quantitative analysis to support the bankers who sold financial instruments. It came into wider use in the 1980s, when academics–pure mathe­maticians and physicists, mostly–began to appear in the financial world in larger numbers. Classic geeks, the newcomers were at first treated as déclassé immigrants by the financial establishment. Emanuel Derman was a theoretical physicist at Columbia University before he joined Goldman Sachs in 1985, and he remembers in his fine memoir My Life as a Quant when “it was bad taste for two consenting adults to talk math or Unix or C in the company of traders, salespeople, and bankers.” But success lent the quants credibility. What was at first a disdainful term was cheerfully embraced by those whom it was originally meant to insult. It finally came to encompass a larger group of people, including, most broadly, anyone involved in mathematical or computational finance. In this article, the word “quant” refers to any practitioner of quantitative finance, a wide-ranging discipline that includes, among other things, the pricing of financial instruments, the evaluation of risk, and the search for exploitable patterns in market data.

A quant sees the financial world through a mathematical lens. This does not necessarily describe the average Wall Street salesperson or trader, whose success is often based as much on intuition and, maybe more important, connections and personal charisma as on any understanding of a topic like stochastic calculus. To give some idea of how far the quant mind is from that of the typical financier, stochastic calculus–a branch of mathematics dealing with randomness–is sometimes derided by quants as “folk math.” The quant, unlike his slicker counterpart, seeks to understand and profit from the markets on a purely numerical basis. Or as Herbert Blank, a quant who devises algorithms for evaluating the financial health of companies, says, “If you think you can find out what you need to know by going to see the management of a company, then I have nothing to say to you.”

If quants in one guise or another have been around for a while, they have also made trouble before. The hedge fund Long-Term Capital Management, which collapsed in August 1998, boasted some of the founders of the field among its directors and officers. Nonetheless, in recent years, quants’ numbers and influence have grown. Over-the-counter derivatives, such as the ones at the heart of the subprime crisis, have become more popular, fueling a boom in lending by making loans easier to trade. The value of over-the-counter derivatives, one shorthand measure of activity in the market, went from $298 trillion in December 2005 to $415 trillion a year later, according to statistics kept by the Bank for International Settle­ments. By some measures, the money invested in two of the most common types of quant funds has grown 60 percent in the last two years (including both expanding assets and new investments), and the funds have generated some of the highest returns in the financial industry.

They’re also among the industry’s most mysterious organizations. Firms that keep their methods secret are known as “black boxes,” and the quant-driven hedge funds are as black as any. It is not unusual for billions of dollars to be invested in such firms with little revealed except the results. Previous results, though, can be a powerful incentive for giving money to someone who won’t tell you what he’s going to do with it. A case in point is James Simons’s Renaissance Technologies, which has earned an average of more than 30 percent a year since its founding in 1988. Like other quant funds, it is ferociously secretive. Still, so many investors have trusted Simons that the two funds under his management now total more than $30 billion. In 2006 alone, he earned $1.7 billion running the fund.

The press often refers to Simons as the world’s leading quant. A world-class mathematician with a PhD from the University of California, Berkeley, he spent years in academia, making significant contributions to mathematics. He worked primarily in geometry and in a subfield called differential geometry, where his most prominent contribution was the Chern-Simons theory, a topological description of quantum field behavior that has been useful to string theorists. Many of his employees have backgrounds in physics, astronomy, and mathematics.

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Credit: Julien Pacaud

Tagged: Business

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