WEBVTT - Interview With Emanuel Derman: Masters in Business (Audio) 0:00:03.240 --> 0:00:07.560 This is Masters in Business with Barry Ridholds on Bloomberg Radio. 0:00:08.480 --> 0:00:11.320 This week on Masters in Business on Bloomberg Radio, we 0:00:11.400 --> 0:00:14.520 have a special guest. If you are a fan of 0:00:14.800 --> 0:00:21.799 quantitative finance, modeling, any application of mathematics to the world 0:00:21.880 --> 0:00:26.119 of investing. UH. This is really a master class in 0:00:27.120 --> 0:00:30.200 what the world used to be like in finance when 0:00:30.240 --> 0:00:34.400 people really you know, math was optional as opposed to 0:00:34.400 --> 0:00:38.000 how things have developed today. Professor Emmanuel Derman is the 0:00:38.159 --> 0:00:42.400 head of Financial Engineering UH coursework in the master's program 0:00:42.400 --> 0:00:47.280 at Columbia University. His background is really quite amazing, and 0:00:47.320 --> 0:00:51.000 I go into a lot of detail UH in the program. 0:00:51.400 --> 0:00:57.120 Suffice it to say at Goldman Sachs, where he UH 0:00:57.520 --> 0:01:04.000 eventually became head of the renowned quantitative Strategies group. Gives 0:01:04.000 --> 0:01:08.480 you an insight of of what sort of UH mathematical 0:01:08.520 --> 0:01:14.640 and programming background he has helped Goldman Sacks make ungodly 0:01:14.760 --> 0:01:19.800 gobs of money by the intelligent application of modeling and 0:01:19.920 --> 0:01:23.240 risk management. A lot of people don't think about the 0:01:23.360 --> 0:01:27.679 blocking and tackling and the basic approach that you have 0:01:27.880 --> 0:01:31.840 to engage in when you're dealing with things like stock 0:01:31.840 --> 0:01:36.520 spoons and options of a liquid assets that that are 0:01:36.560 --> 0:01:39.000 hard to come up with a price because they don't 0:01:39.040 --> 0:01:43.880 necessarily trade all the time anyway. Really a fascinating conversation. 0:01:44.360 --> 0:01:47.960 If you're at all interested in in quantitative finance and modeling, 0:01:48.560 --> 0:01:52.640 um it's and you're not a student at Colombia, you 0:01:52.680 --> 0:01:55.720 don't often get access to someone like Professor Norman, and 0:01:55.800 --> 0:01:59.960 I think you'll find this to be a really interesting conversation. 0:02:00.040 --> 0:02:05.240 And so, without any further ado, my interview with Professor 0:02:05.240 --> 0:02:13.000 Emmanuel Derman. This is Masters in Business with Barry Ridholts 0:02:13.200 --> 0:02:17.040 on Bloomberg Radio. My special guest this week is a 0:02:17.200 --> 0:02:22.360 Manuel Derman. He is a particle physicist and better known 0:02:22.400 --> 0:02:25.760 in the world of finance as a quant His background 0:02:26.080 --> 0:02:30.480 is quite fascinating. Born in South Africa, came to the 0:02:30.560 --> 0:02:36.240 United States later in life, spent seventeen years on Wall Street, 0:02:36.360 --> 0:02:43.040 eventually becoming head of the renowned Quantitative Strategies group at 0:02:43.080 --> 0:02:47.560 Goldman Sachs, where he co developed the Black Derman Toy 0:02:47.680 --> 0:02:51.959 interest Rate model and the Derman Connie local Volatility model, 0:02:52.200 --> 0:02:56.519 both of which have become industry standards. He won the 0:02:56.720 --> 0:03:00.960 I a f E. Sun Guard Financial Engineer of the 0:03:01.040 --> 0:03:05.000 Year Award in two thousand. He's the director of the 0:03:05.040 --> 0:03:09.760 Master's Programming in Financial Engineering at Columbia and author of 0:03:10.080 --> 0:03:13.959 two books, the first, My Life as a quant Reflections 0:03:14.000 --> 0:03:19.440 on Physics and Finance, and more recently, Models Behaving Badly. 0:03:19.960 --> 0:03:23.360 Emmanuel Derman, Welcome to Bloomberg. Thanks, I'm very glad to 0:03:23.400 --> 0:03:26.919 be here. So you're someone whose career I have followed 0:03:26.960 --> 0:03:29.639 for a long time. Uh, and I would imagine a 0:03:29.720 --> 0:03:33.079 lot of our listeners are are probably not familiar with 0:03:33.960 --> 0:03:37.840 either yourself personally or what you do. So let's start 0:03:37.880 --> 0:03:43.280 with a really basic question. What is financial engineering? Okay, 0:03:43.280 --> 0:03:46.480 financial engineering, it's sort of a polyglock field. It's not 0:03:46.560 --> 0:03:49.160 really one simple thing. It developed over the last twenty 0:03:49.200 --> 0:03:53.000 five or thirty years. Um. It's a mix of building 0:03:53.040 --> 0:04:00.560 models for describing businesses and more particularly securities, involving mathematics, artistics, 0:04:00.680 --> 0:04:05.080 the use of computer science programming, all inspired somewhat by 0:04:05.680 --> 0:04:08.320 physics or scientific type models, and using the kind of 0:04:08.320 --> 0:04:12.920 math that's traditionally used in describing the inanimate world of 0:04:12.960 --> 0:04:15.960 the material world, but now applied, for better or for worse, 0:04:16.120 --> 0:04:19.680 to the world of stocks, bonds, securities, options, etcetera. So 0:04:19.680 --> 0:04:22.320 so that naturally leads to the next question, how does 0:04:22.400 --> 0:04:27.880 someone transition from being a specialist in particle physics to 0:04:27.960 --> 0:04:31.760 a specialist in quantitative finance. Yeah, it's like how do 0:04:31.760 --> 0:04:35.640 you get to Carnegie whole practice practice practice. So then, 0:04:36.160 --> 0:04:40.800 so there are obviously some similarities math. Yes, so a 0:04:40.800 --> 0:04:43.160 lot of a lot of them. Modeling in particularly in 0:04:43.240 --> 0:04:46.960 options and in describing fixed income instruments actually has its 0:04:47.040 --> 0:04:52.080 origin in in economists who were trained in physics and 0:04:52.120 --> 0:04:54.799 started applying that kind of math to physics or stochastic 0:04:54.839 --> 0:04:59.839 calculus series discunning already are physics, mathematics and pargular physics 0:04:59.880 --> 0:05:02.559 in spired models, and so it's kind of a fairly 0:05:02.680 --> 0:05:06.200 natural transision for people to make. The trouble is a 0:05:06.200 --> 0:05:10.040 lot of physicists don't have the economics of the finance background. 0:05:10.080 --> 0:05:12.240 And thirty years ago that wasn't a problem. When I 0:05:12.320 --> 0:05:14.720 did it, um, they didn't expect you to know anything. 0:05:14.920 --> 0:05:17.479 The whole quantitative finance field was sort of amateur heaven. 0:05:17.520 --> 0:05:20.400 You just came along and people told you to pick up. 0:05:20.480 --> 0:05:22.200 It happened to me when I came to Golden they said, 0:05:22.200 --> 0:05:24.920 read the Cox Ross rubens Steen model for pricing options 0:05:25.360 --> 0:05:28.120 and start working. And now so it was fairly easy 0:05:28.120 --> 0:05:30.159 in though, is that they hired you if you had potential. 0:05:30.240 --> 0:05:34.560 Now it's a much tougher transcision. It's become a professional field. 0:05:34.600 --> 0:05:37.479 I'm in charge of a program at Columbia where people 0:05:37.520 --> 0:05:40.839 get degrees in the field, professional degrees. And you can't. 0:05:41.080 --> 0:05:44.159 You can't just from an economic point of view. There's 0:05:44.160 --> 0:05:46.159 a glut of people not so easy to get in now. 0:05:46.279 --> 0:05:49.680 So when we look at physics, you're dealing with inanimate 0:05:49.760 --> 0:05:54.920 objects that aren't pushing back. They're not getting excited about rumors, 0:05:54.960 --> 0:05:58.320 they're not getting panicky. But in finance you have the 0:05:58.360 --> 0:06:03.800 individual players who are all suffer from cognitive foibles and 0:06:04.279 --> 0:06:08.400 emotional extremes. How do you adapt to that shift from 0:06:08.680 --> 0:06:13.480 particles which are pretty clean and interesting to humans which 0:06:13.480 --> 0:06:17.840 are messy and volatile. Yeah, that's um. You put your 0:06:17.839 --> 0:06:20.080 finger on the key problem in the whole field, which 0:06:20.120 --> 0:06:24.240 is some people. Yeah, people exactly. And and that's why 0:06:24.279 --> 0:06:26.120 the models don't really work as well. When you make 0:06:26.160 --> 0:06:29.880 a model, even Newtonian mechanics for describing how planets go 0:06:29.960 --> 0:06:31.800 around the Sun, the planets don't really care what you 0:06:31.800 --> 0:06:33.960 say about them, and if you publish an article about 0:06:34.000 --> 0:06:36.279 them that don't change their position even if you have 0:06:36.320 --> 0:06:38.080 the wrong theory about them. But really, if you look 0:06:38.080 --> 0:06:41.000 at what happens in financial markets, they interact with people 0:06:41.040 --> 0:06:44.000 in financial markets all about opinions, and opinions affect the 0:06:44.040 --> 0:06:47.160 future and affect the presence. So um, it's it's a 0:06:47.279 --> 0:06:51.400 much iffier field. And models don't work as well. They 0:06:51.400 --> 0:06:54.360 don't describe the system is accurately, but they're not useless. 0:06:55.200 --> 0:06:58.120 That's the famous George Box quote. All models are wrong, 0:06:58.200 --> 0:07:01.520 but some are useful. Obviously, if you have a useful 0:07:01.560 --> 0:07:04.760 model in finance, it can make a lot of money 0:07:04.839 --> 0:07:09.080 for for its owners. Um, how does somebody like George 0:07:09.080 --> 0:07:14.200 Soros and his theory of reflexivity, how market prices subsequently 0:07:14.240 --> 0:07:17.680 affect market prices? How does that impact someone who's trying 0:07:17.720 --> 0:07:20.880 to create a financial model. Well, I think it impacts 0:07:21.000 --> 0:07:23.360 I think most financial models don't really take a kind 0:07:23.360 --> 0:07:26.400 of reflexivity. There's some some models. Maybe you're starting to 0:07:26.400 --> 0:07:29.920 do that, but I wouldn't say they trading models. Um. 0:07:30.160 --> 0:07:31.880 If I can summarize in one sentence, I would say 0:07:31.880 --> 0:07:34.400 that anytime you build a model, it's a financial model 0:07:34.480 --> 0:07:36.600 is mathematical. You have to keep in the back of 0:07:36.640 --> 0:07:39.520 your head that you're actually short volatility, meaning if the 0:07:39.520 --> 0:07:41.560 world changes, your model is going to be wrong. It 0:07:41.600 --> 0:07:43.480 may make money for you, may lose money for you, 0:07:43.520 --> 0:07:45.920 but it's certainly going to be wrong. Most models only 0:07:45.960 --> 0:07:48.240 work in a very narrow regime where things are more 0:07:48.320 --> 0:07:50.840 or less like the world you're in currently. And you 0:07:50.880 --> 0:07:53.120 see when you get to negative interest rate, for example, 0:07:53.280 --> 0:07:56.160 or when volatility blows up, or when you get you know, 0:07:56.240 --> 0:07:59.720 the Great Financial Crisis, all of these models stopped working. 0:08:00.640 --> 0:08:03.480 Since you you hinted at this in terms of a 0:08:03.560 --> 0:08:06.640 changing regime, I'm thinking about the models that were put 0:08:06.680 --> 0:08:10.360 together by a firm like Long Term Capital Management in 0:08:10.360 --> 0:08:14.880 the late nineties, in the last minute we have. Is 0:08:14.920 --> 0:08:17.920 that why they blew up so spectacularly The world changed 0:08:18.000 --> 0:08:22.040 and their model failed to adapt plus hundred one leverage. Yeah. 0:08:22.080 --> 0:08:24.560 I think my impression of what happened to Long Term 0:08:24.560 --> 0:08:28.560 Capital was that they were basically looking for very small 0:08:28.720 --> 0:08:32.120 deviations most things that earn your money in market, So 0:08:32.240 --> 0:08:34.600 when you buy something liquid, because the liquid things tend 0:08:34.640 --> 0:08:36.120 to be cheap, and so they were buying off the 0:08:36.200 --> 0:08:39.320 run treasuries out of the money options. I don't know 0:08:39.360 --> 0:08:41.600 the details anymore, but essentially things that were cheap, but 0:08:41.640 --> 0:08:43.760 in the long run would revert to the mean and 0:08:43.800 --> 0:08:45.640 give you the full amount. But they leveraged up like 0:08:45.760 --> 0:08:50.680 crazy to accentuate small pennies differences. And then when Russia defaulted, 0:08:51.040 --> 0:08:53.160 what happened was everybody in the world got scared. There's 0:08:53.160 --> 0:08:55.880 a flight to quality. Nobody wants to hold the liquid stuff, 0:08:55.920 --> 0:08:58.280 and they were so overleveraged that they were they were 0:08:58.280 --> 0:09:01.160 put out of business. I'm very ridults. You're listening to 0:09:01.320 --> 0:09:05.080 Masters and Business on Bloomberg Radio. My special guest today 0:09:05.120 --> 0:09:08.400 is a Manuel Derman. He is a professor of financial 0:09:08.440 --> 0:09:12.000 engineering at Columbia University. He used to work at Goldman 0:09:12.040 --> 0:09:15.560 Sachs where he was head of the Quantitative Strategies group. 0:09:16.120 --> 0:09:17.840 And I want to talk a little bit about a 0:09:17.880 --> 0:09:21.000 book you wrote a few years ago after the financial 0:09:21.040 --> 0:09:26.200 crisis called Models Behaving Badly. And one of the first 0:09:26.280 --> 0:09:29.600 things that stood out to me from that book was 0:09:30.840 --> 0:09:35.000 sentence you had written, models are metaphors that explain the 0:09:35.080 --> 0:09:40.080 world we don't understand in terms that we do understand. 0:09:40.480 --> 0:09:45.280 Expand on that. Okay, Um, yeah, that's that's some that's 0:09:45.320 --> 0:09:48.160 my feeling. I can give an example. So what I 0:09:48.240 --> 0:09:50.760 tried to do in that book was distinguished between models 0:09:50.760 --> 0:09:54.080 and theories, as as different means of approaching trying to 0:09:54.120 --> 0:09:59.640 explain the world animate or inanimate, and models seemed to 0:09:59.640 --> 0:10:01.720 me to the analogies in the sense, for example, you 0:10:01.760 --> 0:10:04.280 say the brain is like a computer, or the computer 0:10:04.400 --> 0:10:06.040 is like a brain. People used to say now that 0:10:06.240 --> 0:10:08.560 now they go the other way. Or they say the 0:10:08.600 --> 0:10:10.920 heart is like a water pump. Or there's a great 0:10:10.960 --> 0:10:13.960 quote I like about fixed income from Schopenhauer where he says, 0:10:14.800 --> 0:10:16.800 sleep is the interest that we have to pay on 0:10:16.880 --> 0:10:19.280 the capital which is called in a death. And the 0:10:19.360 --> 0:10:21.679 more regularly the interest is paid, the further the date 0:10:21.720 --> 0:10:25.319 of redemption is postponed. So in other words, it's important 0:10:25.320 --> 0:10:27.520 to get eight hours nights. Yes, and if you can 0:10:27.559 --> 0:10:29.439 get eight hours and I'd sleep. But if you think 0:10:29.440 --> 0:10:31.800 about what he's doing, he's sort of there's a small 0:10:31.840 --> 0:10:35.240 overlap between sleep and between paying interest on a bond, 0:10:35.280 --> 0:10:37.160 which is that you sleep regular and you pay interest 0:10:37.200 --> 0:10:39.240 on a bond. Rey that's really only analogy. And then 0:10:39.559 --> 0:10:41.400 but on a bond, you've borrowed money and you have 0:10:41.440 --> 0:10:42.920 to pay it back at the end. And now he's saying, 0:10:42.960 --> 0:10:44.719 you've borrowed your life from the darkness, and at the 0:10:44.800 --> 0:10:46.240 end you have to pay it back again, and you're 0:10:46.240 --> 0:10:48.880 paying back darkness all the way. So I think that's 0:10:48.880 --> 0:10:53.720 a good example. And most of the models in finance 0:10:53.880 --> 0:10:57.480 or analogies where you say, for example, um in the 0:10:57.559 --> 0:11:01.319 Kape model or in or in in modern finance, you 0:11:01.360 --> 0:11:05.120 say stock prices behave like smoke diffusing from from a 0:11:05.120 --> 0:11:07.720 cigarette end, you know, doing Branny in motion. That's not 0:11:07.840 --> 0:11:11.080 literally true. It could be true, but it isn't. So 0:11:11.120 --> 0:11:14.000 in other words, stock prices don't randomly fill a room 0:11:14.040 --> 0:11:17.600 evenly distributed like the behavior of a gas right, But 0:11:17.760 --> 0:11:21.040 you're creating a metaphor that, hey, it's somewhat random, it's 0:11:21.080 --> 0:11:24.720 a little predictable, but not very predictable, especially over the 0:11:24.760 --> 0:11:28.480 long term exactly. And and for example, in physics, that's 0:11:28.480 --> 0:11:31.680 called Brannyan motion, this motion of diffusion in physics, that 0:11:31.880 --> 0:11:34.680 really is a theory. It's an accurate description of the 0:11:34.679 --> 0:11:37.880 way smoke behaves. But stock prices don't behave that way. 0:11:37.960 --> 0:11:41.719 Volatility jumps, stock prices crash, apple rises are dumps buck 0:11:41.760 --> 0:11:44.520 twenty or thirty bucks in a day more actually son 0:11:44.559 --> 0:11:46.760 of ten percent in a day, So it's not it's 0:11:46.760 --> 0:11:50.679 not a diffusion, it's something that's that's violent. Um, So 0:11:50.760 --> 0:11:53.040 why do we why are we so enamored of all 0:11:53.040 --> 0:11:58.120 these metaphors because we can't do better? And the difference 0:11:58.120 --> 0:12:00.720 is I think economists don't understand. I'll to not be 0:12:00.720 --> 0:12:03.280 too rude about economists, but they don't understand the difference 0:12:03.320 --> 0:12:05.840 between a model and a theory, or a metaphor and 0:12:05.840 --> 0:12:09.600 an accurate description. And physicists, which is my original background, 0:12:09.600 --> 0:12:12.480 actually understand that very well. So for example, if you 0:12:12.559 --> 0:12:16.200 say Newton's laws, which destrive the planets going around the Sun, 0:12:16.360 --> 0:12:20.120 they say four sequals mass times acceleration. That's really accurate. 0:12:20.559 --> 0:12:23.240 It may not be perfect, but it's very accurate. On 0:12:23.280 --> 0:12:25.960 the other hand, they might say a nucleus at the 0:12:26.000 --> 0:12:28.959 center of an atom is like a liquid drop, and 0:12:29.320 --> 0:12:31.360 they understand that when they say a nucleus is like 0:12:31.400 --> 0:12:34.000 a liquid drop, it isn't really a liquid drop. It's 0:12:34.040 --> 0:12:35.760 just a lot like it. But at some point that 0:12:35.760 --> 0:12:38.320 analogy is going to break down, and people get Nobel 0:12:38.360 --> 0:12:40.800 prizes for saying a nucleus is like a liquid drop, 0:12:41.280 --> 0:12:43.480 and they get Nobel prizes for doing what Feynman did, 0:12:43.520 --> 0:12:46.679 which is an accurate description of electrons. But but physicists 0:12:46.720 --> 0:12:49.440 understand that one of them is truth or close to truth, 0:12:49.440 --> 0:12:51.920 and the other one's just a model. So let me 0:12:51.960 --> 0:12:55.560 go off script and say, um, how accurate is it 0:12:55.640 --> 0:13:00.240 to say that economists suffer from physics envy? Uh? I 0:13:00.280 --> 0:13:02.440 don't know who originally coined that. I think maybe Andy Low, 0:13:02.440 --> 0:13:06.240 who's a professor at M I T. I think that's accurate. 0:13:06.280 --> 0:13:08.280 I think maybe it's fading to some extent now The 0:13:08.280 --> 0:13:12.439 behavioral finance people clearly don't. But but yeah they do. 0:13:12.920 --> 0:13:16.040 And you know Bachelier, the guy who started a lot 0:13:16.080 --> 0:13:18.040 of the stuff, and Paul Samuelson, they were all ahead 0:13:18.040 --> 0:13:21.120 of physics smith background somewhere in there. And I noticed 0:13:21.160 --> 0:13:24.920 that you drop a lot of philosophical references in discussion. 0:13:25.080 --> 0:13:28.200 Is that from the financial engineering side or is that 0:13:28.240 --> 0:13:31.480 from the physics side. Um, I've got a late life 0:13:31.520 --> 0:13:35.400 interest in philosophy. Well, it's throughout your books. I notice 0:13:35.440 --> 0:13:37.920 you're you're always referring to that. We'll come back to 0:13:38.040 --> 0:13:41.400 that a little later. Um, let me give you a 0:13:41.480 --> 0:13:46.199 quote of yours that I found intriguing and wildly overlooked 0:13:46.200 --> 0:13:48.800 by a lot of investors. If you want to take 0:13:48.840 --> 0:13:52.520 a chance on the upside, you have also to take 0:13:52.559 --> 0:13:55.679 a chance on the down side. Explain what you mean 0:13:55.760 --> 0:13:58.920 by that, what I mean by that. There was a 0:13:58.960 --> 0:14:01.199 response to I think you wrote a book about this, 0:14:01.320 --> 0:14:04.400 two to the bailouts of two thousand seven eight nine, 0:14:05.200 --> 0:14:08.680 when I felt that there were a lot of companies around, 0:14:08.800 --> 0:14:12.280 banks in particular, but financial companies, that we're taking risk 0:14:12.360 --> 0:14:14.800 and saying that's the essence of capitalism and sort of 0:14:14.880 --> 0:14:16.520 leave me alone and let me, let me do what 0:14:16.559 --> 0:14:20.200 I'm good at. And then suddenly, when everything collapsed, they 0:14:20.280 --> 0:14:24.600 wanted to be saved from death. And I found that incredibly, 0:14:25.280 --> 0:14:29.440 I don't know whether ethically or morally, sort of yeah, 0:14:29.520 --> 0:14:31.280 and saying, oh, the whole system will die if you 0:14:31.320 --> 0:14:33.760 don't save us. And and that's what I meant. If 0:14:33.760 --> 0:14:36.000 you want to be somebody that benefits from taking risk, 0:14:36.120 --> 0:14:39.120 you also have to benefit when taking risk kills you. 0:14:39.600 --> 0:14:41.960 So in other words, you can't have privatized gains and 0:14:42.040 --> 0:14:44.840 socialized laws. Yes, and I like to think that what 0:14:44.920 --> 0:14:46.640 a lot of the banks should have done if they 0:14:46.640 --> 0:14:51.320 were saved by the saved by the government, was they 0:14:51.360 --> 0:14:52.960 were essentially given a put if you look at it 0:14:52.960 --> 0:14:54.840 from an options point of view, they were safe from death, 0:14:55.280 --> 0:14:57.520 and if they were given a put they should have 0:14:57.520 --> 0:15:01.040 given away a call to the when they were When 0:15:01.080 --> 0:15:04.760 they survived, companies had a little a I G. Gave 0:15:04.800 --> 0:15:07.880 the government some uh, I mean it was forced upon them, 0:15:07.880 --> 0:15:10.280 and then the G S, C S, Fannie and Freddie 0:15:10.400 --> 0:15:15.240 they essentially became Yeah, yeah, so that's fair. You can't 0:15:15.240 --> 0:15:19.360 get ten million dollar bonuses the rfter you was saved from. 0:15:19.960 --> 0:15:22.960 Makes sense that should we have nationalized those companies, cleaned 0:15:23.000 --> 0:15:25.840 them up, and then spun them out as free standing 0:15:25.880 --> 0:15:28.360 companies with the benefits of those I p o s 0:15:28.400 --> 0:15:31.400 going to the taxpayer? Is that a better ethical way 0:15:31.400 --> 0:15:33.280 to do that. I think it's a better ethical way 0:15:33.280 --> 0:15:34.960 to do it. I have friends who argue with this 0:15:35.000 --> 0:15:37.160 about him. They say the whole system would have collapsed 0:15:37.200 --> 0:15:39.840 if we hadn't bailed them out. Um, people are not 0:15:39.920 --> 0:15:42.480 what the FED who say everything was credit was on 0:15:42.520 --> 0:15:46.200 the verge of sort of freezing up. But I think 0:15:46.200 --> 0:15:49.520 it's left a permanent um, a permanent bad taste in 0:15:49.560 --> 0:15:54.600 everybody's mouth. Certainly created moral hazard that Hey, you know, look, 0:15:54.800 --> 0:15:58.880 it's arguable to say we rescued bear Sterns and the 0:15:58.960 --> 0:16:02.120 FED backed up JP Morgan's purchase, and that might have 0:16:02.280 --> 0:16:06.240 given the impetus to Lehman Brothers to say someone will 0:16:06.280 --> 0:16:09.360 come along and rescue us. Right? Is that fair? Fair 0:16:09.400 --> 0:16:11.560 assessment of that? There was a funny cartoon. This was 0:16:11.560 --> 0:16:14.240 a little maybe not right, but there was a funny 0:16:14.240 --> 0:16:17.400 cartoon by Barry Blitzer or Berry Blitzer, forget his name 0:16:17.480 --> 0:16:20.440 is in New York and New Yorker cartoonists who had 0:16:20.440 --> 0:16:23.160 a picture somewhere in two thousand and eight of Obama 0:16:23.320 --> 0:16:26.360 dressed as a as a New York City policeman with 0:16:26.400 --> 0:16:29.960 a hat and a navy navy uniform and walking down 0:16:30.040 --> 0:16:32.920 the street tooling of a ton with these eyes cast 0:16:33.000 --> 0:16:34.520 up in heaven as though he couldn't see what was 0:16:34.520 --> 0:16:36.480 around him, and meanwhile people behind him or running with 0:16:36.520 --> 0:16:39.880 bags of money into buildings. And that's sort of typified, 0:16:40.760 --> 0:16:44.120 typified it for me. But it was certainly an interesting period. 0:16:44.520 --> 0:16:47.320 I'm Barry Ridults. You're listening to Masters in Business on 0:16:47.360 --> 0:16:50.760 Bloomberg Radio. My special guest today is a manual German. 0:16:51.120 --> 0:16:56.080 He spent seventeen years at Goldman Sachs, eventually becoming head 0:16:56.200 --> 0:17:00.480 of the renowned quantitative strategies group. He all So is 0:17:00.600 --> 0:17:06.280 currently uh, the director of financial Engineering at Columbia University. 0:17:06.280 --> 0:17:09.600 It's a master's program, I believe is that the master's program. 0:17:09.600 --> 0:17:12.520 It's a sort of travel month eighteen month professional degree. 0:17:12.720 --> 0:17:16.440 He also is the author of Models Behaving Badly and 0:17:17.200 --> 0:17:21.359 My Life as a Quant Reflections on Physics and Finance. 0:17:21.560 --> 0:17:24.719 Let's talk a little bit about quants on Wall Street. 0:17:25.040 --> 0:17:28.360 You mentioned when you began twenty five years ago or so, 0:17:28.760 --> 0:17:31.439 it was a wide open field. There was no playbook. 0:17:32.359 --> 0:17:35.800 But here it is. We have high frequency trading, we 0:17:35.840 --> 0:17:40.040 have al go driven strategies, we we have all manners 0:17:40.200 --> 0:17:48.880 of mathematical um investing, mathematically based investing. Is this the 0:17:48.960 --> 0:17:52.920 age of the quant? Yeah? I think it is. Actually, 0:17:53.000 --> 0:17:55.800 I mean when I started out, very few traders were 0:17:55.920 --> 0:17:57.959 very numerous. They didn't know a lot of math, they 0:17:58.000 --> 0:18:00.840 hadn't studied. A lot of them came from law backgrounds 0:18:00.840 --> 0:18:03.320 and stuff like that. And now, in fact, quant was 0:18:03.359 --> 0:18:07.200 a derogatory word. I've got a dictionary from the late 0:18:07.320 --> 0:18:10.200 nineties where somebody it's it's by Mark Chritsman, called a 0:18:10.280 --> 0:18:14.280 dictionary financial terms, and he says quanton. He says quantity 0:18:14.320 --> 0:18:16.800 of analysts often used pejoratively and when I wrote that 0:18:16.840 --> 0:18:19.200 book called My Life as a Quant. What was actually 0:18:19.200 --> 0:18:20.520 in the back of my head was I took my 0:18:20.600 --> 0:18:23.640 kids twenty five years ago to see us a Swedish 0:18:23.640 --> 0:18:26.760 movie called My Life as a Dog. You see, there 0:18:26.800 --> 0:18:29.280 was a great movie as for kids and parents to 0:18:29.320 --> 0:18:32.040 see simultaneously, and I was seeing on My Life as 0:18:32.040 --> 0:18:33.480 a Dog. That was really the back in the back 0:18:33.480 --> 0:18:35.359 of my mind. When I came to Goldman, quant was 0:18:35.400 --> 0:18:37.040 a sort of like being a geek or being a 0:18:38.320 --> 0:18:40.720 and people laughed at you, although they kind of treated 0:18:40.760 --> 0:18:42.520 you with respect. I liked it, but it was a 0:18:42.600 --> 0:18:45.240 kind of mocking kind of respect. So since you brought 0:18:45.280 --> 0:18:47.639 that up, let me go back to a question I missed. 0:18:48.000 --> 0:18:50.840 So you were at Goldman Sachs in the ninety nineties, 0:18:50.880 --> 0:18:53.480 that had to be one of the questions I was 0:18:53.480 --> 0:18:56.320 going to ask you, was how were the quants treated? 0:18:56.480 --> 0:18:59.120 So you you said there was some degree of respect, 0:18:59.560 --> 0:19:03.240 but was it was there? Were you treated as one 0:19:03.320 --> 0:19:07.159 of their own? Or were you guys kind of on 0:19:07.240 --> 0:19:10.480 the outskirts and people, you know, slipped pizza under the 0:19:10.520 --> 0:19:14.359 door and kind of left you alone. Um, that's funny. 0:19:14.400 --> 0:19:18.280 It varied, it varied um for a while for a 0:19:18.280 --> 0:19:20.760 while I worked for Fisher Black in his group, and 0:19:20.800 --> 0:19:23.600 then he had everybody sit on the desk and get 0:19:23.680 --> 0:19:25.879 lunch when the traders got lunch, and you were kind 0:19:25.880 --> 0:19:28.440 of more equal. But generally I would say, that didn't 0:19:28.520 --> 0:19:32.639 last long, and people people treated you like like geeks, 0:19:32.680 --> 0:19:35.399 but like useful but useful people that they spoke to you. 0:19:35.440 --> 0:19:37.920 What's the expression useful idiots? Is that how they looked 0:19:37.920 --> 0:19:42.119 at did was that the action when I got in 0:19:42.320 --> 0:19:44.240 When I got there in eighty five, which was earlier, 0:19:44.240 --> 0:19:46.119 people would get in the elevator and sort of make 0:19:46.200 --> 0:19:47.920 jokes and say, oh, all of you allowed to travel 0:19:47.960 --> 0:19:51.080 in the same elevator at the same time. Or I 0:19:51.080 --> 0:19:52.520 would be with I wrote about it in my life 0:19:52.520 --> 0:19:53.879 as a quant. I would be with some guy and 0:19:53.920 --> 0:19:55.720 I would I was very excited about being on Wall 0:19:55.760 --> 0:19:57.439 Street and it was interesting. I would say something to 0:19:57.520 --> 0:20:00.840 him about duration or convexity, and he would get embarrassed 0:20:00.880 --> 0:20:02.720 and shrink away and say, what do you think of 0:20:02.760 --> 0:20:04.640 the Yankees last night? You know? So, in other words, 0:20:04.640 --> 0:20:06.800 he didn't know what convects it your duration? Actually now 0:20:06.800 --> 0:20:08.199 he knew what it was. He just didn't want to 0:20:08.200 --> 0:20:11.119 be outed in the fation in other words, he was 0:20:11.160 --> 0:20:14.359 a geek, but he didn't he didn't like me talking 0:20:14.359 --> 0:20:17.040 about it in public. But then, but then, even in 0:20:17.040 --> 0:20:20.840 the early nineties, you know, I remember when not just Quantz, 0:20:20.880 --> 0:20:24.080 but everybody. If you had a PhD, you didn't put 0:20:24.080 --> 0:20:25.600 it on your business card, and if you had an 0:20:25.640 --> 0:20:27.600 email address, you didn't put it on your business card 0:20:27.640 --> 0:20:29.479 because that was like the brand of Caine. You know, 0:20:30.440 --> 0:20:35.160 that's amazing. I think that that's early nineties. People didn't 0:20:35.160 --> 0:20:38.840 want to put email addresses or or or PhD degrees 0:20:38.880 --> 0:20:41.040 on their business card. Now, of course they'd love to 0:20:41.080 --> 0:20:45.600 do it. That's wow. Become things have changed. So you 0:20:45.600 --> 0:20:49.399 were Goldman when they went public, right, what what was 0:20:49.480 --> 0:20:53.600 that like from the experience of someone with your background 0:20:54.119 --> 0:20:56.560 on Wall Street? You know, I think things were steadily 0:20:56.600 --> 0:20:58.879 improving for quans Alo at the same time Goldman was 0:20:58.880 --> 0:21:01.800 getting much more bureaucrats. But by that time, you've been 0:21:01.880 --> 0:21:05.800 through UM long Term Capital, You've been through d Shore, 0:21:06.000 --> 0:21:10.280 so LTCM, so all sorts of hedge funds starting to 0:21:10.280 --> 0:21:13.119 make a lot of money out of supposedly quantitative strategies, 0:21:13.160 --> 0:21:17.080 and and particularly the whole Internet Internet and not Bubble, 0:21:17.160 --> 0:21:21.600 but the whole Internet excitement where suddenly um being being 0:21:21.640 --> 0:21:24.760 technologically competent became a way to make money. And so 0:21:24.800 --> 0:21:29.000 that even destroying destroying the whole system, like LTC M 0:21:29.840 --> 0:21:32.000 gave you, gave you respect. So things were getting better 0:21:32.000 --> 0:21:34.800 for quants. But by the late nineties, I have to 0:21:34.840 --> 0:21:39.399 think renaissance technologies had been putting up absurd returns for 0:21:39.440 --> 0:21:43.600 a long time, right, And if memory serves didn't Jim 0:21:43.640 --> 0:21:48.720 Simon's return outside investors money sometime around then is maybe 0:21:48.720 --> 0:21:50.439 a little bit later, but yeah, they only have their 0:21:50.480 --> 0:21:53.840 own money now, which is which is tells you, hey, 0:21:53.880 --> 0:21:57.439 these guys are really putting up huge returns without a 0:21:57.440 --> 0:22:01.439 whole lot of capacity to do it. In the tens 0:22:01.440 --> 0:22:05.160 of billions your d shore as well returns outside money. 0:22:05.480 --> 0:22:07.840 And no, I didn't return outside money, but we're very 0:22:07.920 --> 0:22:11.800 visible and and at that point don't people look around 0:22:11.840 --> 0:22:14.360 and say, hey, these guys are minting money. Let's get 0:22:14.400 --> 0:22:16.600 us some quants, and maybe we need to pay these 0:22:16.640 --> 0:22:19.840 people proper respect. Well, they gave them respect, and they 0:22:19.840 --> 0:22:22.320