Was It All the Fault of the Quants?

by: Felix Salmon

The most emailed article on nytimes.com today is Dennis Overbye's piece on quants -- which has already resulted in something of a smackdown from Rick Bookstaber.

I'm not a huge fan of the Overbye piece, and not only because his sidebar on David Li and the Gaussian copula function seems weirdly familiar to me. The whole thing seems overwrought, somehow: is finance really "a world in which a few percent one way can land you in jail"? Did Black-Scholes really manage to seemingly "guarantee profits" in options pricing? And does the existence of the volatility smile really invalidate most quants' models?

I know first hand how hard it is to write about quantitative finance for a lay audience without oversimplifying massively. And Overbye gave himself such an enormous remit -- everything from volatility smiles and Gaussian copulas to big-picture stuff about the rise of the quants and the criticisms of Nassim Taleb -- that there's simply no way he could have really got up to speed on all of this material in time for his deadline.

I also know that I'm not the intended audience here. But the fact is that Overbye has made it all too easy for his readers to simply blame the quants: he certainly doesn't help himself by referring nonchalantly to "the ultimately disastrous growth of credit derivatives" amid other nods to popular prejudice, like the idea that "one bad bet can doom a hedge fund".

As Bookstaber says, it wasn't really the quants' fault; it wasn't even really the risk officers' fault. If you're looking for bankers to blame, blame the executives, who were willfully blind to everything that the risk officers were telling them about tail risks. It's the executives who took the numbers generated by VaR or copula calculations and treated them as something certain, rather than something highly volatile.

But another article blaming bank executives for willfully being blind to risks wouldn't be fresh or new, so now the caravan seems to have moved on to the quants. Which is fair enough for a day or two -- they're hardly blameless, after all. But let's not lose sight of the bigger picture.