1 00:00:07,480 --> 00:00:11,480 Speaker 1: Hello, and welcome to another episode of the Odd Lots Podcast. 2 00:00:11,600 --> 00:00:15,440 Speaker 1: I'm Joe Wisenthal, Managing editor at Bloomberg Markets, and I'm 3 00:00:15,440 --> 00:00:19,239 Speaker 1: Tracy Alloway, Executive editor at Bloomberg Markets. So, Tracy, you 4 00:00:19,280 --> 00:00:23,040 Speaker 1: know what's something really fun about having a podcast? Okay, 5 00:00:23,120 --> 00:00:26,799 Speaker 1: tell me what that I can read a book or 6 00:00:26,880 --> 00:00:30,840 Speaker 1: read an article and then two days later say, hey, 7 00:00:30,880 --> 00:00:33,640 Speaker 1: we should have the author of that in that article 8 00:00:33,800 --> 00:00:36,839 Speaker 1: or book on to discuss that, and we can do that. 9 00:00:36,960 --> 00:00:38,800 Speaker 1: I think that's a really cool thing. Is this podcast 10 00:00:38,840 --> 00:00:41,479 Speaker 1: is going to become like Joe's book Club. It's basically 11 00:00:41,479 --> 00:00:44,519 Speaker 1: going to become Yeah, basically it's going to be just 12 00:00:44,640 --> 00:00:46,600 Speaker 1: here's what Joe read the week before and wants to 13 00:00:46,640 --> 00:00:50,280 Speaker 1: talk more about. You know, but I, well, I can live. Yeah, 14 00:00:50,400 --> 00:00:52,000 Speaker 1: it won't be that bad. I read good stuff. But 15 00:00:52,920 --> 00:00:55,360 Speaker 1: uh so, I recently had the chance to read the 16 00:00:55,400 --> 00:00:59,200 Speaker 1: book My Life as a quant by Emmanuel Derman, who 17 00:00:59,440 --> 00:01:04,000 Speaker 1: was a physic assist theoretical physicist who eventually joined Wall 18 00:01:04,040 --> 00:01:08,680 Speaker 1: Street during the quantitative revolution and sort of was at 19 00:01:08,720 --> 00:01:10,920 Speaker 1: all you know, all these sort of there's so much 20 00:01:10,959 --> 00:01:15,200 Speaker 1: talk about the equations and models that run finance these days, 21 00:01:15,880 --> 00:01:19,240 Speaker 1: and he was at the ground floor of how that 22 00:01:19,400 --> 00:01:22,720 Speaker 1: all got built up. Oh well, that's exciting. We've talked 23 00:01:22,800 --> 00:01:26,440 Speaker 1: plenty about mathematical models and their role in finance on 24 00:01:26,480 --> 00:01:30,840 Speaker 1: this podcast before, so exactly so, why not exactly so, 25 00:01:31,040 --> 00:01:34,720 Speaker 1: why not talk to one of the very original practitioners 26 00:01:34,760 --> 00:01:38,760 Speaker 1: of it. And we have Emmanuel here in studio. So um, 27 00:01:38,800 --> 00:01:41,720 Speaker 1: I say, let's get started. Let's do it. Emmanuel, thanks 28 00:01:41,760 --> 00:01:44,360 Speaker 1: for joining us, my pleasure. I'm really glad to be here. 29 00:01:44,840 --> 00:01:47,480 Speaker 1: So I want to start with something in your book. 30 00:01:47,560 --> 00:01:50,080 Speaker 1: One of the things that really struck me was you 31 00:01:50,160 --> 00:01:56,520 Speaker 1: pointed out how the explosion of exotic equity derivatives was 32 00:01:56,720 --> 00:02:01,160 Speaker 1: very much tied to the globalization of fine and after 33 00:02:01,200 --> 00:02:04,040 Speaker 1: the Cold War ended. And there's really seemed like a 34 00:02:04,120 --> 00:02:08,120 Speaker 1: poignant thing to read right now after the Brexit vote, 35 00:02:08,160 --> 00:02:13,040 Speaker 1: when it feels like the world is arguably deglobalizing a 36 00:02:13,080 --> 00:02:16,960 Speaker 1: little bit. Finance seems to be in retreat. But explain 37 00:02:17,080 --> 00:02:19,520 Speaker 1: to us the connection there, because I thought that that 38 00:02:19,600 --> 00:02:22,560 Speaker 1: was something that I had never thought of until I 39 00:02:22,600 --> 00:02:25,040 Speaker 1: read your book. Yeah, that's very interesting. It's funny. Nobody's 40 00:02:25,040 --> 00:02:27,720 Speaker 1: ever mentioned that to me about my book before I 41 00:02:27,840 --> 00:02:31,680 Speaker 1: joined them. Equity derivatives at Goldman. I've been in fix income. 42 00:02:31,720 --> 00:02:34,560 Speaker 1: I joined Equit Derivatives in early and I was in 43 00:02:34,639 --> 00:02:38,639 Speaker 1: charge of the quantitative Strategies group and we basically supported 44 00:02:39,240 --> 00:02:43,160 Speaker 1: the options disc And there was this flowering of interest 45 00:02:43,200 --> 00:02:47,239 Speaker 1: in exotic options because and it was because of globalization essentially, 46 00:02:47,320 --> 00:02:50,560 Speaker 1: once the Berlin Wall came down, people wanted to invest 47 00:02:50,600 --> 00:02:53,639 Speaker 1: in foreign in foreign stock markets. They didn't want to 48 00:02:53,639 --> 00:02:57,280 Speaker 1: buy individual stocks, so they used options, which was much simpler. 49 00:02:57,320 --> 00:02:59,639 Speaker 1: There were indicas developed all over the world, from the 50 00:02:59,720 --> 00:03:03,120 Speaker 1: NICK to the CAC to the decks, and everybody went 51 00:03:03,160 --> 00:03:04,880 Speaker 1: to the part of it. And there was also this 52 00:03:05,000 --> 00:03:07,760 Speaker 1: fashion in finance forum. Well it's still going on for 53 00:03:07,840 --> 00:03:09,880 Speaker 1: sort of not just buying your own country, not just 54 00:03:09,919 --> 00:03:13,239 Speaker 1: buying the stock of your own company. Canadian actually Canadian 55 00:03:13,440 --> 00:03:16,240 Speaker 1: pension funds used to come to US because Canadian pension 56 00:03:16,240 --> 00:03:19,000 Speaker 1: funds weren't allowed to buy more than a small amount 57 00:03:19,000 --> 00:03:21,040 Speaker 1: of foreign stock, and so they would do their exposure 58 00:03:21,080 --> 00:03:24,079 Speaker 1: through derivatives. Yes, so explain that a little bit more. 59 00:03:24,080 --> 00:03:28,960 Speaker 1: I think people understand what essentially an option is, but explain, well, 60 00:03:29,000 --> 00:03:31,679 Speaker 1: why are they called exotic options and why do they 61 00:03:31,720 --> 00:03:36,160 Speaker 1: have an important role in giving people this international exposure Okay, 62 00:03:36,200 --> 00:03:38,960 Speaker 1: I'm glad you're asking that. No nobody have asked it before. 63 00:03:39,080 --> 00:03:42,200 Speaker 1: The Well, an option is the right, but not the obligation, 64 00:03:42,280 --> 00:03:44,600 Speaker 1: to buy something for a certain price in the future. 65 00:03:44,640 --> 00:03:47,920 Speaker 1: So for example, you might have have the right to 66 00:03:47,960 --> 00:03:50,440 Speaker 1: buy IBM a U from today at a hundred dollars 67 00:03:50,520 --> 00:03:52,560 Speaker 1: or whatever it is, and if IBM is training above 68 00:03:52,600 --> 00:03:54,760 Speaker 1: a hundred dollars at that point, you can buy it 69 00:03:54,760 --> 00:03:56,320 Speaker 1: for a hundred dollars, sell it for a hundred and 70 00:03:56,360 --> 00:03:57,920 Speaker 1: ten if it's training a hundred and ten, and make 71 00:03:57,960 --> 00:04:01,240 Speaker 1: ten bucks. And that's what people called vanilla standard call, 72 00:04:01,480 --> 00:04:05,000 Speaker 1: and there's a put similarly, but with exotic options. They 73 00:04:05,040 --> 00:04:08,360 Speaker 1: allowed you to get a much more fine tuned exposure 74 00:04:08,440 --> 00:04:11,160 Speaker 1: to different things. So, for example, the first thing I 75 00:04:11,200 --> 00:04:14,160 Speaker 1: worked on, which was kind of famous, not not me individally, 76 00:04:14,200 --> 00:04:17,600 Speaker 1: but a Goldman, was something called the Nike Um the 77 00:04:17,680 --> 00:04:20,440 Speaker 1: Nick put options, where Goldman issued put some the Nike 78 00:04:20,960 --> 00:04:23,120 Speaker 1: and the Nick was trading at I don't remember what 79 00:04:23,160 --> 00:04:24,640 Speaker 1: it was. That it's all time high of like twenty 80 00:04:24,720 --> 00:04:26,880 Speaker 1: nine thousand or something like that. And there are a 81 00:04:26,880 --> 00:04:29,360 Speaker 1: lot of people who were skeptical about the future of Japan. Rightly, 82 00:04:29,360 --> 00:04:33,240 Speaker 1: as it turns out and Goldman sold puts on the Nike. 83 00:04:33,560 --> 00:04:36,560 Speaker 1: But the reason they were exotic was people wanted a 84 00:04:36,560 --> 00:04:38,520 Speaker 1: better the Nike going down, but they didn't want to 85 00:04:38,560 --> 00:04:40,839 Speaker 1: face currency risk. And normally, if you bought to put 86 00:04:40,839 --> 00:04:43,320 Speaker 1: on the Nike, the Nike might go down, but the 87 00:04:43,440 --> 00:04:45,599 Speaker 1: end might strengthen, and so you wouldn't make any money 88 00:04:45,600 --> 00:04:48,239 Speaker 1: even if the Nick went down. And what was exotic 89 00:04:48,279 --> 00:04:52,279 Speaker 1: about these so called quanto options were that you locked 90 00:04:52,279 --> 00:04:54,520 Speaker 1: in a guaranteed exchange rate. It didn't matter what the 91 00:04:54,600 --> 00:04:58,080 Speaker 1: yen dollar did. When you exercise your option, you got 92 00:04:58,080 --> 00:05:01,760 Speaker 1: paid in dollars the amount that the unique dropped in percent. 93 00:05:01,920 --> 00:05:04,159 Speaker 1: It was a put am i making sense. So that 94 00:05:04,279 --> 00:05:07,480 Speaker 1: was exotic because so in other words, it's not just 95 00:05:07,560 --> 00:05:10,839 Speaker 1: a plane of the net, it's not a plane embedded 96 00:05:10,880 --> 00:05:15,279 Speaker 1: in it. Are more scenarios and more hedges, yes, or 97 00:05:15,279 --> 00:05:17,400 Speaker 1: actually less in a sense. You if you bought an 98 00:05:17,440 --> 00:05:19,760 Speaker 1: ordery put on the Nick, you would be exposed to 99 00:05:19,800 --> 00:05:22,440 Speaker 1: both the yen dollar and to the Nike, and this 100 00:05:22,520 --> 00:05:25,120 Speaker 1: way you remove the end dollar. So people would do 101 00:05:25,160 --> 00:05:28,080 Speaker 1: this kind of stuff, or people would buy knockout options, 102 00:05:28,080 --> 00:05:31,279 Speaker 1: which were very popular, which is an option that gives 103 00:05:31,279 --> 00:05:33,240 Speaker 1: you money if it's called gives you money if the 104 00:05:33,360 --> 00:05:37,200 Speaker 1: stock rises, but gets knocked out if the stock drops 105 00:05:37,240 --> 00:05:38,919 Speaker 1: too low, if the stock drops too high. All of 106 00:05:38,920 --> 00:05:43,919 Speaker 1: these ways were basically ways of making speculative bets. By 107 00:05:44,000 --> 00:05:46,120 Speaker 1: putting up less money than you would for vanial option, 108 00:05:46,200 --> 00:05:48,680 Speaker 1: you were betting on a smaller range of probabilities than 109 00:05:48,760 --> 00:05:51,440 Speaker 1: just what was what was reflected in an ordinary option. 110 00:05:52,000 --> 00:05:55,359 Speaker 1: And Emmanuel, one thing I always wonder about when it 111 00:05:55,400 --> 00:05:59,120 Speaker 1: comes to these sorts of exotic options and instruments is 112 00:05:59,200 --> 00:06:01,880 Speaker 1: you're allowing me in vestor to sort of fine tune 113 00:06:01,920 --> 00:06:06,120 Speaker 1: their risk. But how do the banks that are actually 114 00:06:06,480 --> 00:06:09,839 Speaker 1: offering these kind of products, how did they manage their risk? 115 00:06:09,880 --> 00:06:14,279 Speaker 1: Because things like knockout options can be you know, um 116 00:06:14,360 --> 00:06:18,599 Speaker 1: kind of painful for the issuer, right, yes, So I 117 00:06:18,600 --> 00:06:21,680 Speaker 1: mean that that was my job exactly. We we Golden 118 00:06:21,760 --> 00:06:25,400 Speaker 1: for example, issued these exotic options, but if you sold 119 00:06:25,400 --> 00:06:27,840 Speaker 1: them to somebody, you didn't want to suffer when they 120 00:06:27,880 --> 00:06:30,479 Speaker 1: made money. So you had to head yourself. And you 121 00:06:30,480 --> 00:06:32,800 Speaker 1: couldn't just buy an exotic option from one person and 122 00:06:32,839 --> 00:06:36,000 Speaker 1: sell it to another, So you had to deconstructed and 123 00:06:36,720 --> 00:06:39,480 Speaker 1: what black shoals and all the extensions of option pricing 124 00:06:39,520 --> 00:06:42,800 Speaker 1: do is tell you essentially how to synthesize an option 125 00:06:43,000 --> 00:06:45,279 Speaker 1: or an exotic option from the underlying which is the 126 00:06:45,320 --> 00:06:49,320 Speaker 1: currency and the and the nique itself. Am I making sense? 127 00:06:50,600 --> 00:06:53,600 Speaker 1: I'm not sure? No? Absolutely, Okay. So so the models 128 00:06:53,640 --> 00:06:56,039 Speaker 1: we worked on, which I did for ten years, told 129 00:06:56,040 --> 00:06:59,840 Speaker 1: you how to dynamically every day trade the end dollar 130 00:07:00,320 --> 00:07:04,560 Speaker 1: and every day trade the nika in order to replicate 131 00:07:04,600 --> 00:07:06,679 Speaker 1: what you were selling to somebody else. You were selling 132 00:07:06,720 --> 00:07:09,000 Speaker 1: them a package and now you had created for yourself 133 00:07:09,000 --> 00:07:11,320 Speaker 1: so that when they won, you wouldn't lose. Yeah. I 134 00:07:11,360 --> 00:07:14,440 Speaker 1: love the way in your book essentially described it as 135 00:07:15,400 --> 00:07:21,200 Speaker 1: you're buying raw material, some combination of equity, cash the end, 136 00:07:21,640 --> 00:07:24,760 Speaker 1: and then you're repackaging it and basically selling it as 137 00:07:24,800 --> 00:07:28,840 Speaker 1: a mark up like any other manufacturer done. Honestly, that's 138 00:07:28,840 --> 00:07:31,760 Speaker 1: what it is. You're you're a middleman, you're a market maker, 139 00:07:31,880 --> 00:07:35,680 Speaker 1: You're you're a wholesaler. You're buying complex stuff that people 140 00:07:35,800 --> 00:07:39,280 Speaker 1: want to sell, and you're decomposing it into its constituents, 141 00:07:39,400 --> 00:07:42,800 Speaker 1: or you're selling people complex stuff and making it out 142 00:07:42,800 --> 00:07:45,400 Speaker 1: of out of simple constituents. So it's really I think, 143 00:07:45,400 --> 00:07:47,160 Speaker 1: I say in my book it's a bit like fruit salad. 144 00:07:47,200 --> 00:07:49,040 Speaker 1: If you want to know what you should charge for 145 00:07:49,080 --> 00:07:51,160 Speaker 1: fruit salad, you have to know the cost of canning, 146 00:07:51,200 --> 00:07:54,440 Speaker 1: the price of pears, apples, peaches, etcetera. And then you 147 00:07:54,440 --> 00:07:56,720 Speaker 1: you had a spread for your risk. Because the models 148 00:07:56,720 --> 00:07:59,800 Speaker 1: are really a little bit shaky. So let's actually let's 149 00:07:59,800 --> 00:08:03,280 Speaker 1: go back. Tell you mentioned the black skulls method, but 150 00:08:03,680 --> 00:08:08,760 Speaker 1: tell us about your beginning on Wall Street where quantitative 151 00:08:08,760 --> 00:08:11,760 Speaker 1: finance was, and when you joined, and then what you 152 00:08:11,880 --> 00:08:14,120 Speaker 1: worked on in your earlier years. You know, I came 153 00:08:14,160 --> 00:08:18,080 Speaker 1: to Goldman. I've been a physicist before that, and then 154 00:08:18,080 --> 00:08:20,640 Speaker 1: I worked for five years of the labs, where I 155 00:08:20,640 --> 00:08:24,080 Speaker 1: already learned a lot of software engineering, which was very useful, 156 00:08:24,120 --> 00:08:27,800 Speaker 1: and I joined Goldman in and the hot thing in 157 00:08:27,840 --> 00:08:30,240 Speaker 1: those days interest rates were coming down from the high 158 00:08:30,240 --> 00:08:34,480 Speaker 1: of sev We've lived through a massive bull market in 159 00:08:34,520 --> 00:08:38,760 Speaker 1: bonds right now. And I worked on black shoals explained 160 00:08:38,760 --> 00:08:41,560 Speaker 1: how to price options on stock. But now people were 161 00:08:41,600 --> 00:08:45,800 Speaker 1: interested in buying options on bonds because as interest rates 162 00:08:45,800 --> 00:08:48,120 Speaker 1: came down, people want to speculate on them going up 163 00:08:48,120 --> 00:08:50,040 Speaker 1: again or going down again. And so there was a 164 00:08:50,080 --> 00:08:53,760 Speaker 1: big market in options on treasury bonds. And the first 165 00:08:53,800 --> 00:08:55,679 Speaker 1: thing I did was work with Fisher Black and a 166 00:08:55,720 --> 00:08:58,240 Speaker 1: colleague of mine, Bill Toy, on trying to extend Black 167 00:08:58,280 --> 00:09:03,559 Speaker 1: Shoals into seeing yield curve things. Bonds and bunds a 168 00:09:03,600 --> 00:09:06,679 Speaker 1: paid coupons rather than stocks. And bonds are very different 169 00:09:06,720 --> 00:09:10,520 Speaker 1: from stocks because stocks have no termination date, but bunds 170 00:09:10,640 --> 00:09:13,440 Speaker 1: have a finite life, and and you really need a 171 00:09:13,480 --> 00:09:16,280 Speaker 1: totally different model. And I worked on something called b 172 00:09:16,400 --> 00:09:19,160 Speaker 1: d T everybody called it Black Dermon Toy, which was 173 00:09:19,280 --> 00:09:21,440 Speaker 1: one of the early models I did. That. The world's 174 00:09:21,440 --> 00:09:23,880 Speaker 1: gotten much more complicated since then. People make much more 175 00:09:23,880 --> 00:09:27,000 Speaker 1: elaborate models. So the way you describe the eighties and 176 00:09:27,200 --> 00:09:30,760 Speaker 1: the sort of explosion in exotic options, it almost sounds 177 00:09:30,800 --> 00:09:34,080 Speaker 1: like a sort of industrial revolution type thing for the 178 00:09:34,160 --> 00:09:38,800 Speaker 1: financial industry. Suddenly you have this big evolution happening in 179 00:09:39,120 --> 00:09:42,360 Speaker 1: products in ways to manage risk, and it kind of 180 00:09:42,440 --> 00:09:46,440 Speaker 1: leads to, um, I guess, more revenue and growth of 181 00:09:46,480 --> 00:09:50,360 Speaker 1: the financial industry as well. Yes, it was everybody. It 182 00:09:50,480 --> 00:09:54,240 Speaker 1: was a globalization. Um, it was the ability to trade 183 00:09:54,240 --> 00:09:58,960 Speaker 1: forim markets suddenly. UM it was Actually I wasn't academic before. 184 00:09:59,000 --> 00:10:01,520 Speaker 1: It was actually very excited. Everybody was waking up every 185 00:10:01,600 --> 00:10:04,040 Speaker 1: day to new products coming out and trying to or 186 00:10:04,080 --> 00:10:05,840 Speaker 1: your bank wanted to issue new products, and you were 187 00:10:05,840 --> 00:10:08,400 Speaker 1: trying to figure out how to value them and hedge 188 00:10:08,400 --> 00:10:10,880 Speaker 1: them because they want to eliminate as much risk for 189 00:10:10,920 --> 00:10:13,640 Speaker 1: themselves as possible. And so there was a there was 190 00:10:13,679 --> 00:10:17,520 Speaker 1: a Yeah, there was a literal sort of efflorescence of 191 00:10:17,640 --> 00:10:21,240 Speaker 1: papers on exotic options and how to hedge volatility and 192 00:10:21,280 --> 00:10:23,760 Speaker 1: the invention I worked on variant swaps, which are ways 193 00:10:23,760 --> 00:10:28,280 Speaker 1: of trading volatility rather than stocks. So how did you 194 00:10:28,320 --> 00:10:33,480 Speaker 1: feel about actually leaving physics and academia and going to 195 00:10:33,559 --> 00:10:36,680 Speaker 1: Wall Street because I imagine it must have been quite 196 00:10:36,679 --> 00:10:40,400 Speaker 1: a different work environment, right, Yes, I was. I was 197 00:10:40,559 --> 00:10:43,800 Speaker 1: very ashamed. You know people who in physics, and even 198 00:10:43,840 --> 00:10:46,280 Speaker 1: I have colleagues today, you are in physics, they go 199 00:10:46,360 --> 00:10:48,320 Speaker 1: into I wrote about this in my book. They're go 200 00:10:48,320 --> 00:10:51,440 Speaker 1: into physics a little bit like um with a religious 201 00:10:51,480 --> 00:10:54,320 Speaker 1: sort of fervor, thinking they're getting to discover something fundamental, 202 00:10:54,400 --> 00:10:58,560 Speaker 1: or try to discover something fundamental, and Um, everybody looks 203 00:10:58,600 --> 00:11:01,439 Speaker 1: down on you if you start to become practical, if 204 00:11:01,440 --> 00:11:03,480 Speaker 1: you start to go out to make a living. We 205 00:11:03,559 --> 00:11:08,120 Speaker 1: all despised people who did that, and eventually I did that. Too. Yeah. 206 00:11:07,559 --> 00:11:10,640 Speaker 1: I think one of the little anecdotes in your book 207 00:11:10,679 --> 00:11:13,240 Speaker 1: was about having some friend who who went to work 208 00:11:13,280 --> 00:11:18,800 Speaker 1: on traffic patterns in the city and feeling sorry for Himmer. Yeah. Yeah, 209 00:11:18,840 --> 00:11:21,000 Speaker 1: even though it sounds like interesting stuff, it is. One 210 00:11:21,040 --> 00:11:23,480 Speaker 1: of the lessons I've learned is that is that actually 211 00:11:23,480 --> 00:11:25,640 Speaker 1: everything is interesting. It's sort of like to see the 212 00:11:25,640 --> 00:11:27,439 Speaker 1: world in a grain of sand. If you look hard enough, 213 00:11:27,480 --> 00:11:30,280 Speaker 1: then a lot of things become interesting. But physics felt 214 00:11:30,280 --> 00:11:32,079 Speaker 1: a bit like a religion, and people look down on 215 00:11:32,160 --> 00:11:34,080 Speaker 1: you when you sort of left the monastery, and I 216 00:11:34,160 --> 00:11:36,000 Speaker 1: felt that for a while. I spent five years at 217 00:11:36,080 --> 00:11:39,000 Speaker 1: Bell Labs, which was interesting, but but it was my 218 00:11:39,040 --> 00:11:41,280 Speaker 1: first experience of working in the corporation and I sort 219 00:11:41,320 --> 00:11:43,640 Speaker 1: of hated it. And then when I came to gold 220 00:11:43,720 --> 00:11:46,520 Speaker 1: to Wall Street, into Goldman, I actually loved it because 221 00:11:46,720 --> 00:11:49,160 Speaker 1: they kind of took an academic interest in this stuff, 222 00:11:49,520 --> 00:11:53,320 Speaker 1: and so you woke up every morning working on something interesting. 223 00:11:53,520 --> 00:11:55,920 Speaker 1: But at the same time there were people who really 224 00:11:55,920 --> 00:11:58,920 Speaker 1: wanted it. Yeah. Actually, I'm one thing I still didn't 225 00:11:59,000 --> 00:12:03,520 Speaker 1: quite understand. So while you were working for Goldman, you 226 00:12:03,640 --> 00:12:08,559 Speaker 1: also published papers regularly and sort of publicized your findings. 227 00:12:08,880 --> 00:12:11,800 Speaker 1: How does that work. The tension of wanting to have 228 00:12:11,880 --> 00:12:15,880 Speaker 1: a model that allows Goldman to profit while also wanting 229 00:12:15,960 --> 00:12:19,240 Speaker 1: to do research that the public can know about and 230 00:12:19,280 --> 00:12:21,840 Speaker 1: you can have your name attached to. Yeah, that's that's 231 00:12:21,840 --> 00:12:24,800 Speaker 1: some I think that's pretty much vanished. People on Wall Street, 232 00:12:24,920 --> 00:12:28,040 Speaker 1: especially with Sabain's Oxley passing ten or fifteen years ago, 233 00:12:28,640 --> 00:12:31,199 Speaker 1: they they don't publish much research anymore. But I grew 234 00:12:31,280 --> 00:12:35,600 Speaker 1: up in an era where people developed new things and 235 00:12:35,679 --> 00:12:39,160 Speaker 1: unless somebody really insisted that they were incredibly proprietary like now, 236 00:12:39,200 --> 00:12:42,599 Speaker 1: for example, algorithmic trading, people people want published papers on. 237 00:12:42,800 --> 00:12:46,240 Speaker 1: But the options business was by and large a sales business. 238 00:12:46,640 --> 00:12:48,640 Speaker 1: You know, you were making money not so much from 239 00:12:48,640 --> 00:12:53,800 Speaker 1: speculating in volatility, but from providing people services and and 240 00:12:53,840 --> 00:12:56,559 Speaker 1: the more you educated your clients, the better they understood 241 00:12:56,559 --> 00:12:58,960 Speaker 1: what you were trying to do. So it was a 242 00:12:58,960 --> 00:13:01,320 Speaker 1: bit of a struggle, but worked for Fisher Black and 243 00:13:01,840 --> 00:13:04,280 Speaker 1: I pushed quite hard. We had a culture where where 244 00:13:04,559 --> 00:13:07,079 Speaker 1: unless somebody it's sort out, where you could never publish. 245 00:13:07,160 --> 00:13:09,679 Speaker 1: And then it became for a few years like they 246 00:13:09,679 --> 00:13:12,680 Speaker 1: had to say you can't publish, rather than you can publish. 247 00:13:13,160 --> 00:13:17,000 Speaker 1: Did you ever get pushed back from your employers, Goldman 248 00:13:17,200 --> 00:13:21,760 Speaker 1: or someone else about I guess the real world application 249 00:13:21,840 --> 00:13:23,800 Speaker 1: of some of the stuff you're doing, or its ability 250 00:13:23,840 --> 00:13:25,880 Speaker 1: to generate money. Like if you were working on a 251 00:13:25,920 --> 00:13:28,920 Speaker 1: project and they couldn't exactly see the commercial interest in it, 252 00:13:29,000 --> 00:13:33,560 Speaker 1: would they ask you to stop? Yeah, I mean, you know, 253 00:13:33,600 --> 00:13:36,079 Speaker 1: I published a lot of papers and I like doing that, 254 00:13:36,320 --> 00:13:37,880 Speaker 1: and I had a big group of people that did 255 00:13:37,880 --> 00:13:40,360 Speaker 1: that and and sometimes actually contact me, and they said 256 00:13:40,360 --> 00:13:43,280 Speaker 1: they didn't realize what a rare environment it was, because 257 00:13:43,280 --> 00:13:46,200 Speaker 1: most people weren't allowed to do that. But we did that. 258 00:13:46,240 --> 00:13:49,280 Speaker 1: But at the same time, our real job was building 259 00:13:50,040 --> 00:13:53,200 Speaker 1: risk management systems for the people that traded equity derivatives, 260 00:13:53,640 --> 00:13:55,760 Speaker 1: and so I would say we sort of earned our 261 00:13:55,840 --> 00:13:59,000 Speaker 1: keep by building software that embedded these models and that 262 00:13:59,160 --> 00:14:02,079 Speaker 1: let the manage that positions. And at the same time 263 00:14:02,280 --> 00:14:04,800 Speaker 1: we had to build new models, and they moral miss 264 00:14:04,840 --> 00:14:07,559 Speaker 1: agreed to let us publish, so they sometimes didn't like it. 265 00:14:08,559 --> 00:14:11,720 Speaker 1: One of the things that I found that maybe everybody 266 00:14:11,800 --> 00:14:14,240 Speaker 1: knew this before me, but that I did not know 267 00:14:14,360 --> 00:14:16,800 Speaker 1: until I read it in your book, was that the 268 00:14:17,960 --> 00:14:22,600 Speaker 1: seven stock market crash caused a permanent change to the 269 00:14:22,640 --> 00:14:26,720 Speaker 1: financial market landscape in terms of how options before that 270 00:14:26,800 --> 00:14:29,680 Speaker 1: crashed price in afterwards, and that had permanently changed the 271 00:14:29,720 --> 00:14:32,640 Speaker 1: way people value things. Can you explain what happened? Yes, 272 00:14:32,720 --> 00:14:35,400 Speaker 1: I can, um, and I'll make you writing a textbook. 273 00:14:35,560 --> 00:14:37,600 Speaker 1: I've just finished the textbook on that right now. But 274 00:14:38,360 --> 00:14:42,280 Speaker 1: but what happened in before seven? People pretty much use 275 00:14:42,400 --> 00:14:45,000 Speaker 1: the Black Sholes model to price options. Is it too 276 00:14:45,040 --> 00:14:48,600 Speaker 1: technical to talk about different strikes? Okay, with different strikes, 277 00:14:48,920 --> 00:14:50,760 Speaker 1: and they still use the same model and the tribute 278 00:14:50,800 --> 00:14:53,760 Speaker 1: to the same risk to the stock that lay underneath 279 00:14:53,760 --> 00:14:58,280 Speaker 1: the option. But after when the market dropped in October, 280 00:14:58,360 --> 00:15:01,280 Speaker 1: in one day, all of a sudden, all hell broke loose, 281 00:15:01,320 --> 00:15:04,320 Speaker 1: and from then on everybody being a bit anthropomorphic, but 282 00:15:04,400 --> 00:15:08,800 Speaker 1: everybody understood that markets tend to crash down and glide up, 283 00:15:09,040 --> 00:15:10,760 Speaker 1: which is kind of what's been happening here too. You 284 00:15:10,800 --> 00:15:13,480 Speaker 1: get a big move down, but you get slow moves up. 285 00:15:13,840 --> 00:15:16,000 Speaker 1: And so if the world is more likely to move 286 00:15:16,040 --> 00:15:18,840 Speaker 1: down dramatically but go up slowly, you ought to charge 287 00:15:18,880 --> 00:15:21,000 Speaker 1: more money for a put which will make money when 288 00:15:21,000 --> 00:15:24,800 Speaker 1: the market drops. And everybody immediately did that, and it's 289 00:15:24,840 --> 00:15:27,680 Speaker 1: been like that ever since. It amazes me that the 290 00:15:27,720 --> 00:15:30,520 Speaker 1: idea that markets don't crash up and only crash down 291 00:15:30,640 --> 00:15:34,120 Speaker 1: was something that wasn't reflected in the market until seven. 292 00:15:34,160 --> 00:15:36,160 Speaker 1: I mean we had market we had stock market crashes 293 00:15:36,200 --> 00:15:38,840 Speaker 1: before then. Yeah, I guess there was no options market 294 00:15:38,880 --> 00:15:43,200 Speaker 1: in in nine. And the options market didn't really get 295 00:15:43,240 --> 00:15:46,920 Speaker 1: big until Black Black Controls published their paper in seventy three. 296 00:15:47,400 --> 00:15:50,040 Speaker 1: And yeah, there was a fourteen year period where where 297 00:15:50,080 --> 00:15:53,000 Speaker 1: people didn't worry too much about the stuff. And it's 298 00:15:53,000 --> 00:15:54,640 Speaker 1: been like that ever since. And in fact, the gold 299 00:15:54,640 --> 00:15:58,200 Speaker 1: market changed in the late nineties because central central banks 300 00:15:58,280 --> 00:16:01,800 Speaker 1: in some central in Switzerland did something other about gold, 301 00:16:01,800 --> 00:16:05,440 Speaker 1: and ever since then, gold tends to crash up when 302 00:16:05,440 --> 00:16:07,760 Speaker 1: the market goes down. Gold doesn't gold. Gold tends to 303 00:16:07,800 --> 00:16:10,240 Speaker 1: go down slowly and go up dramatically, and so you 304 00:16:10,280 --> 00:16:13,280 Speaker 1: get an inverse sort of option behavior that's been there since. 305 00:16:14,680 --> 00:16:17,680 Speaker 1: So all this talk about market crashes is kind of 306 00:16:17,760 --> 00:16:20,520 Speaker 1: reminding me of what's going on right now. In the 307 00:16:20,600 --> 00:16:24,320 Speaker 1: aftermath of the Brexit referendum in the UK, um we 308 00:16:24,360 --> 00:16:27,120 Speaker 1: obviously saw markets sell off after that, but we saw 309 00:16:27,160 --> 00:16:32,240 Speaker 1: a lot of people worrying about what systematic traders, uh, 310 00:16:32,360 --> 00:16:34,760 Speaker 1: you know, like risk parity guys, that sort of thing, 311 00:16:34,760 --> 00:16:37,520 Speaker 1: what they would do. And those guys have been likened 312 00:16:37,560 --> 00:16:42,560 Speaker 1: before to sort of modern portfolio ensures in the sense 313 00:16:43,000 --> 00:16:46,120 Speaker 1: that they could create this sort of feedback loop during 314 00:16:46,120 --> 00:16:48,400 Speaker 1: a big sell off. I love to get your thoughts 315 00:16:48,400 --> 00:16:51,080 Speaker 1: on that. I think that's true. I think anybody who 316 00:16:51,120 --> 00:16:56,200 Speaker 1: behaves mechanically um um is behaving a bit like portfolio insurance, 317 00:16:56,320 --> 00:16:59,200 Speaker 1: and and if people know it's coming, they start to 318 00:16:59,280 --> 00:17:01,360 Speaker 1: try to dodge it. I mean, there's pretty people have 319 00:17:01,400 --> 00:17:03,480 Speaker 1: actually done very well in the best few months because 320 00:17:04,040 --> 00:17:10,160 Speaker 1: they like them they invest equally in bonds, stocks and commodities, 321 00:17:10,200 --> 00:17:13,720 Speaker 1: and all of those things have gone up so um. 322 00:17:13,760 --> 00:17:16,080 Speaker 1: But yes, since they're behaving mechanically, there is a danger 323 00:17:16,200 --> 00:17:19,439 Speaker 1: that they keep doing the same thing. And and you 324 00:17:19,480 --> 00:17:21,280 Speaker 1: can only be clever if you're a small part of 325 00:17:21,280 --> 00:17:23,040 Speaker 1: the of the ocean. But if you're the whole ocean, 326 00:17:23,080 --> 00:17:26,879 Speaker 1: then then and everybody doing the same thing, then your 327 00:17:26,920 --> 00:17:30,440 Speaker 1: models don't work because you're actually affecting affecting the thing 328 00:17:30,480 --> 00:17:34,080 Speaker 1: you're trying to model. So yeah, I think that could happen. Uh. 329 00:17:34,240 --> 00:17:38,040 Speaker 1: You mentioned that part of the reason you did the 330 00:17:38,080 --> 00:17:40,760 Speaker 1: work earlier. Early on in your work, there was a 331 00:17:40,760 --> 00:17:42,760 Speaker 1: lot of demand for it because there was a major 332 00:17:42,840 --> 00:17:45,840 Speaker 1: shift in the direction of interest rates. Right now, interest 333 00:17:45,920 --> 00:17:48,119 Speaker 1: rates are only going in one direction. Every day we 334 00:17:48,160 --> 00:17:51,960 Speaker 1: wake up to new lower rates around the world. Presumably 335 00:17:52,760 --> 00:17:55,359 Speaker 1: one day that will change. It could be next week, 336 00:17:55,359 --> 00:17:58,640 Speaker 1: it could be years from now. When that does happen, 337 00:17:59,119 --> 00:18:02,240 Speaker 1: will we see once again lots of models just being 338 00:18:02,240 --> 00:18:05,840 Speaker 1: completely destroyed and types of portfolios not working, and a 339 00:18:05,920 --> 00:18:09,800 Speaker 1: sort of really really looking at how to do all 340 00:18:09,800 --> 00:18:12,479 Speaker 1: this stuff. That's I mean, I think that's already happening. 341 00:18:12,480 --> 00:18:14,480 Speaker 1: That's a perceptive question. If you look at the thing 342 00:18:14,480 --> 00:18:17,600 Speaker 1: I mentioned earlier, this Black Derman toy model, and essentially 343 00:18:17,600 --> 00:18:19,639 Speaker 1: all the interest rate models that people built, they always 344 00:18:19,640 --> 00:18:22,960 Speaker 1: assumed rates could never go negative. If you try buying software, 345 00:18:22,960 --> 00:18:25,520 Speaker 1: they actually won't let you enter a negative rate. And 346 00:18:25,560 --> 00:18:27,760 Speaker 1: so I don't really work on this stuff anymore, but 347 00:18:27,800 --> 00:18:29,760 Speaker 1: I think a lot of people have been working for 348 00:18:29,840 --> 00:18:33,840 Speaker 1: banks on how do you value options when when there's 349 00:18:33,840 --> 00:18:36,080 Speaker 1: actually a negative interest rate which the previous model just 350 00:18:36,119 --> 00:18:40,200 Speaker 1: didn't allow. And I mean, this stuff is very different 351 00:18:40,200 --> 00:18:41,880 Speaker 1: from physics, I try to point out in my book 352 00:18:41,880 --> 00:18:43,720 Speaker 1: because in physics, once you figure out the way the 353 00:18:43,760 --> 00:18:46,280 Speaker 1: planets work, they say that way, they don't really care 354 00:18:46,280 --> 00:18:48,120 Speaker 1: what you say about them. But when you figure out 355 00:18:48,160 --> 00:18:50,639 Speaker 1: a model for markets and everybody uses it, as Tracy 356 00:18:50,720 --> 00:18:52,959 Speaker 1: was pointing out, it actually starts to affect the thing 357 00:18:53,000 --> 00:18:56,800 Speaker 1: you're modeling, and so no model asks forever you know, 358 00:18:56,840 --> 00:18:58,879 Speaker 1: there's there's some It lives for a while, and then 359 00:18:58,920 --> 00:19:01,359 Speaker 1: people get smarter when the market, which is what happened, 360 00:19:01,400 --> 00:19:03,840 Speaker 1: and he said, when the market suddenly misbehaves and they 361 00:19:03,840 --> 00:19:05,960 Speaker 1: adjust their model, and it's it's sort of an endless 362 00:19:06,000 --> 00:19:08,840 Speaker 1: leap frog in a way. Well, I suppose that gets 363 00:19:08,880 --> 00:19:11,800 Speaker 1: to the heart of one of the major criticisms leveled 364 00:19:11,880 --> 00:19:15,200 Speaker 1: at quantitative finance and at models, which is that how 365 00:19:15,320 --> 00:19:18,200 Speaker 1: useful are they really? We hear all the time about 366 00:19:18,240 --> 00:19:21,240 Speaker 1: like ten sigma events in markets, things that are only 367 00:19:21,320 --> 00:19:24,400 Speaker 1: supposed to happen every you know, one day in five 368 00:19:24,480 --> 00:19:26,840 Speaker 1: million years, and things like that, and they seem to 369 00:19:26,920 --> 00:19:31,560 Speaker 1: keep happening. So clearly the models are missing something, right, Yeah, 370 00:19:31,640 --> 00:19:35,720 Speaker 1: you're right, I think. Yeah, I've written a lot about 371 00:19:35,720 --> 00:19:38,399 Speaker 1: the section. I think models are only good as as 372 00:19:38,480 --> 00:19:42,200 Speaker 1: long as the world stays in the sort of regime 373 00:19:42,240 --> 00:19:44,440 Speaker 1: that you're currently in, and then they provide a good 374 00:19:44,440 --> 00:19:46,879 Speaker 1: way of valuing things as long as things change a 375 00:19:46,880 --> 00:19:48,480 Speaker 1: little bit, not too much. When you move to a 376 00:19:48,480 --> 00:19:51,920 Speaker 1: new regime like negative interest rates or this old central 377 00:19:51,920 --> 00:19:54,840 Speaker 1: bank um sort of the last seven years of risk 378 00:19:54,880 --> 00:19:59,880 Speaker 1: on risk off, then your old models don't work. And yeah, 379 00:20:00,040 --> 00:20:02,359 Speaker 1: kind of like to say, it's idolatry to imagine that 380 00:20:02,400 --> 00:20:05,720 Speaker 1: you can write down an equation that's going to accurately 381 00:20:05,760 --> 00:20:09,560 Speaker 1: reflect the way people behave. Uh So let's sort of 382 00:20:10,440 --> 00:20:12,240 Speaker 1: start or go back to where we talked about in 383 00:20:12,280 --> 00:20:16,680 Speaker 1: the beginning, with the connection of globalization and exotic options. 384 00:20:17,119 --> 00:20:21,159 Speaker 1: In the wake of the Brexit vote, arguably finite the 385 00:20:21,200 --> 00:20:26,040 Speaker 1: world maybe deglobalizing somewhat. What is uh, what is your 386 00:20:26,040 --> 00:20:29,080 Speaker 1: assessment of the financial industry these days? Every day we 387 00:20:29,119 --> 00:20:34,760 Speaker 1: wake up to news about layoffs, retrenchments, large banks divesting 388 00:20:34,880 --> 00:20:39,640 Speaker 1: their their foreign subsidiaries. Where do you see the industry going? 389 00:20:41,800 --> 00:20:43,960 Speaker 1: You know, it goes in cycles. When I when I 390 00:20:44,000 --> 00:20:46,280 Speaker 1: started out, it was very important to be able to 391 00:20:46,320 --> 00:20:49,240 Speaker 1: program and to do quantitative work. Then at some point 392 00:20:49,880 --> 00:20:52,480 Speaker 1: being able to program became a commodity that you could 393 00:20:52,480 --> 00:20:54,040 Speaker 1: give to the I T people and you just did 394 00:20:54,080 --> 00:20:58,000 Speaker 1: theoretical work, which I never really liked. And now now 395 00:20:58,040 --> 00:21:01,119 Speaker 1: exotic options are sort of pretty much a small market 396 00:21:01,160 --> 00:21:05,280 Speaker 1: nobody's interested in that anymore. Everything's done electronically and algorithmically, 397 00:21:05,320 --> 00:21:09,960 Speaker 1: and so software skills for for financial companies and investment 398 00:21:09,960 --> 00:21:12,960 Speaker 1: banks and for hedge funds have become much more important. 399 00:21:13,080 --> 00:21:15,160 Speaker 1: And so I'm looking for the point of the job 400 00:21:15,200 --> 00:21:18,560 Speaker 1: market students now. Students now have to be good programmers 401 00:21:18,600 --> 00:21:20,280 Speaker 1: if they want to get a job, which didn't used 402 00:21:20,280 --> 00:21:22,600 Speaker 1: to be the case ten or fifteen years ago. So 403 00:21:22,920 --> 00:21:25,720 Speaker 1: I think everything is moving away from exoticism and towards 404 00:21:25,760 --> 00:21:32,680 Speaker 1: vanilla products um algorithmic trading, high frequency trading by computer. 405 00:21:33,920 --> 00:21:35,399 Speaker 1: That's what it's been like for the last five or 406 00:21:35,440 --> 00:21:38,000 Speaker 1: six years, and I don't see that ending soon. Does 407 00:21:38,040 --> 00:21:41,399 Speaker 1: that make you happy or sad? The idea that some 408 00:21:41,480 --> 00:21:44,720 Speaker 1: of the exoticism of Wall Street might be going away 409 00:21:44,760 --> 00:21:47,000 Speaker 1: now A little bit sad in the sense that I 410 00:21:47,040 --> 00:21:49,920 Speaker 1: had a good time. What was nice about the years 411 00:21:49,960 --> 00:21:53,840 Speaker 1: that I worked at Goldman was that Goldman functioned in 412 00:21:53,880 --> 00:21:56,359 Speaker 1: a very informal and bureaucratic way, at least for the 413 00:21:56,400 --> 00:21:58,520 Speaker 1: first and for the first ten years I was there, 414 00:21:58,560 --> 00:22:00,919 Speaker 1: And if you worked with the trading desk, it was 415 00:22:00,960 --> 00:22:03,040 Speaker 1: a bit like being in physics. There were a bunch 416 00:22:03,080 --> 00:22:05,200 Speaker 1: of traders who are like the experimentalists and a bunch 417 00:22:05,200 --> 00:22:07,320 Speaker 1: of quantity with the theorists, and you all spoke every 418 00:22:07,400 --> 00:22:09,880 Speaker 1: day and you work together, and it was kind of exciting. 419 00:22:10,600 --> 00:22:13,480 Speaker 1: And I think what's said a little bit for me 420 00:22:13,520 --> 00:22:16,640 Speaker 1: now is that most of the jobs for people are 421 00:22:16,640 --> 00:22:21,440 Speaker 1: in bureaucracy and risk management and risk reporting in basle regulations. 422 00:22:22,040 --> 00:22:27,159 Speaker 1: And yeah, very very um very driven by regulation and 423 00:22:27,200 --> 00:22:31,000 Speaker 1: reporting rather than actually trying to do new things. Is 424 00:22:31,119 --> 00:22:35,560 Speaker 1: the regulation, while it may be boring and not exciting, 425 00:22:35,720 --> 00:22:37,800 Speaker 1: is it, i net, a good thing for society or 426 00:22:37,840 --> 00:22:40,880 Speaker 1: do you think it could be a counterproductive. I think 427 00:22:40,920 --> 00:22:43,080 Speaker 1: it's good up to a point. But I'm a bit 428 00:22:43,119 --> 00:22:45,719 Speaker 1: of a skeptic about I'm a bit of a skeptic 429 00:22:45,760 --> 00:22:49,119 Speaker 1: about what's happened in the last ideas I think they 430 00:22:49,119 --> 00:22:51,080 Speaker 1: should have. I think that I think that the way 431 00:22:51,119 --> 00:22:53,240 Speaker 1: people learn a good lesson is when they go bankrupt, 432 00:22:53,320 --> 00:22:55,639 Speaker 1: when they lost a lot of money by being stupid, 433 00:22:55,680 --> 00:22:57,920 Speaker 1: or by being careless, or but just just by the 434 00:22:58,000 --> 00:23:00,159 Speaker 1: fact that that's the way the world works. And I 435 00:23:00,200 --> 00:23:03,960 Speaker 1: think nothing's nothing prevents people from doing bad things again, 436 00:23:04,000 --> 00:23:06,920 Speaker 1: except getting punished by the market for having done them. 437 00:23:07,200 --> 00:23:11,600 Speaker 1: And I think forty page of regulation. Are are not 438 00:23:11,720 --> 00:23:15,399 Speaker 1: an adequate substitute for just letting people go under when 439 00:23:15,440 --> 00:23:23,160 Speaker 1: they do badly? Easy to say, I know, but but nevertheless, 440 00:23:23,240 --> 00:23:26,560 Speaker 1: Uh so you mentioned that you're working on a textbook. 441 00:23:27,720 --> 00:23:30,080 Speaker 1: Let's what is that? And also just what else are 442 00:23:30,119 --> 00:23:34,359 Speaker 1: you interested in these days? Um, I'm working. I taught 443 00:23:34,600 --> 00:23:37,120 Speaker 1: a course on the volatility smile on this thing that 444 00:23:37,440 --> 00:23:40,399 Speaker 1: happens in seven for the last ten or fifteen years, 445 00:23:40,800 --> 00:23:42,760 Speaker 1: mostly based on the work I did at Goldman, and 446 00:23:42,800 --> 00:23:44,840 Speaker 1: so I've just finished a textbook on that, which is 447 00:23:44,840 --> 00:23:47,320 Speaker 1: coming out in September, and it has a very pretty 448 00:23:47,359 --> 00:23:49,320 Speaker 1: cover from I don't know if you know who hockey 449 00:23:49,320 --> 00:23:52,800 Speaker 1: s I was. He was some Spanish woodcutter a picture 450 00:23:52,840 --> 00:23:55,000 Speaker 1: of a big wave which looks like a volatility smile. 451 00:23:55,400 --> 00:24:00,320 Speaker 1: So I'm finished that. Um. I wrote another are called 452 00:24:00,320 --> 00:24:03,080 Speaker 1: Models Behaving Badly, which was more philosophical about the difference 453 00:24:03,119 --> 00:24:05,200 Speaker 1: between models and physics. And I kind of like, I 454 00:24:05,240 --> 00:24:06,680 Speaker 1: don't know, I've I've spent a lot of time doing 455 00:24:06,720 --> 00:24:12,240 Speaker 1: quantitative stuff. I prefer doing qualitative stuff and writing. Now, Um, 456 00:24:12,280 --> 00:24:14,880 Speaker 1: there's actually I'm working a little bit with the guy 457 00:24:15,600 --> 00:24:18,359 Speaker 1: who's the professor of anthropology. This is kind of interesting 458 00:24:18,400 --> 00:24:21,119 Speaker 1: at at at the News School, and there are a 459 00:24:21,119 --> 00:24:22,760 Speaker 1: whole bunch of them who are very interested in the 460 00:24:22,800 --> 00:24:25,840 Speaker 1: anthropology of finance and the way traders behave. And it's 461 00:24:25,880 --> 00:24:28,960 Speaker 1: kind of interesting because traders use models that they know 462 00:24:29,000 --> 00:24:31,959 Speaker 1: are wrong, but nevertheless they keep using them in a 463 00:24:31,960 --> 00:24:35,880 Speaker 1: more or less effective way. And we're interested in sort 464 00:24:35,920 --> 00:24:38,920 Speaker 1: of looking at at at how this works. And plus 465 00:24:40,040 --> 00:24:41,919 Speaker 1: he's got this idea, which I think is right. It's 466 00:24:41,920 --> 00:24:45,480 Speaker 1: a little that that that volatility became an interesting thing 467 00:24:45,840 --> 00:24:49,000 Speaker 1: in society in the last fifteen in the last thirty years. 468 00:24:49,320 --> 00:24:52,160 Speaker 1: If you look at them, if you look at people 469 00:24:52,200 --> 00:24:56,400 Speaker 1: writing surfboards are doing skateboarding, they're actually doing something very similar. 470 00:24:56,440 --> 00:25:00,360 Speaker 1: When they go up and down, up and down, they're 471 00:25:00,400 --> 00:25:04,159 Speaker 1: sort of hedging out there there. Maybe I'm getting to 472 00:25:04,200 --> 00:25:08,240 Speaker 1: complicate this is okay. Well, when you value an option, 473 00:25:08,920 --> 00:25:11,359 Speaker 1: you first hedge it, and so you get rid of 474 00:25:11,400 --> 00:25:13,879 Speaker 1: the pure market risk and what you left with is 475 00:25:13,880 --> 00:25:16,320 Speaker 1: a sort of convexity kind of shape that's just the 476 00:25:17,000 --> 00:25:19,800 Speaker 1: residual part of the option. And it's very similar in 477 00:25:19,840 --> 00:25:23,000 Speaker 1: a in a metaphorical way to what skateboarders, or to 478 00:25:23,040 --> 00:25:26,560 Speaker 1: what surfers do when they ride. They ride a wave, 479 00:25:26,840 --> 00:25:29,480 Speaker 1: and they're not interested in the horizontal motion. They're interested 480 00:25:29,520 --> 00:25:31,320 Speaker 1: in moving up and down the curve of the wave 481 00:25:31,760 --> 00:25:35,520 Speaker 1: as it as it curls. And um, this friend of 482 00:25:35,520 --> 00:25:38,200 Speaker 1: mine is sort of interested in the whole idea of 483 00:25:39,280 --> 00:25:41,800 Speaker 1: people in the world since the early seventies being interested 484 00:25:41,840 --> 00:25:45,080 Speaker 1: in volatility as a as a as a quantity, the 485 00:25:45,119 --> 00:25:47,439 Speaker 1: same way as people use options to trade volatility as 486 00:25:47,480 --> 00:25:50,480 Speaker 1: an asset. So you know, people who wander through city 487 00:25:50,560 --> 00:25:53,800 Speaker 1: streets and try to experience the excitement rather than trying 488 00:25:53,800 --> 00:25:55,840 Speaker 1: to go somewhere. Is a is a sort of version 489 00:25:55,880 --> 00:26:01,560 Speaker 1: of of optionality. Interesting. Well, it sounds like fascinating stuff, 490 00:26:02,000 --> 00:26:04,280 Speaker 1: and I hope you are now. I really want to 491 00:26:04,359 --> 00:26:07,200 Speaker 1: read more about this stuff, and I hope you write 492 00:26:07,240 --> 00:26:09,680 Speaker 1: on it. Okay, Um, yeah, my textbook is going to 493 00:26:09,720 --> 00:26:12,560 Speaker 1: be a technical book, although I'm very against if I 494 00:26:12,560 --> 00:26:16,160 Speaker 1: can say one more thing, Um, finance and financial engineering 495 00:26:16,200 --> 00:26:19,360 Speaker 1: has gotten very mathematical in the last fifteen or twenty years, 496 00:26:19,440 --> 00:26:21,880 Speaker 1: and I kind of disapproved people teach it as though 497 00:26:21,880 --> 00:26:24,000 Speaker 1: it's a branch of mathematics, but really it's a real 498 00:26:24,040 --> 00:26:27,680 Speaker 1: world field and it shouldn't have theorems or axioms. It's 499 00:26:27,720 --> 00:26:30,440 Speaker 1: about the way the world behaves, and I'm I'm trying 500 00:26:30,480 --> 00:26:32,480 Speaker 1: to write my textbook in that way too, and a 501 00:26:32,520 --> 00:26:36,040 Speaker 1: little bit of a of a counter counterpoint to the 502 00:26:36,080 --> 00:26:39,159 Speaker 1: way that people people often teach finance. Now it's a 503 00:26:39,200 --> 00:26:41,680 Speaker 1: branch of pure math, as though you write down axioms 504 00:26:41,720 --> 00:26:43,400 Speaker 1: and you you know, like Uclid, and you work out 505 00:26:43,400 --> 00:26:45,880 Speaker 1: the results, and the world doesn't really work that way. 506 00:26:46,000 --> 00:26:48,000 Speaker 1: And as you point out, all models are wrong. It's 507 00:26:48,000 --> 00:26:51,720 Speaker 1: just yes, which which ones are less wrong? Yes? Alright, 508 00:26:51,800 --> 00:26:55,360 Speaker 1: Emmanuel German, author of My Life as a quant and 509 00:26:55,680 --> 00:26:59,320 Speaker 1: Models Behaving Badly and a forthcoming textbook on the volatility smile. 510 00:26:59,640 --> 00:27:02,240 Speaker 1: Thank very much for joining us. Thanks, someone's glad to 511 00:27:02,280 --> 00:27:08,560 Speaker 1: be here. Well, Tracy, I I loved that discussion. I'm 512 00:27:08,720 --> 00:27:13,400 Speaker 1: guessing you did too, me too, I gradgically admit I 513 00:27:13,400 --> 00:27:17,160 Speaker 1: I will join the Joe Wisenthal book Club in future. 514 00:27:17,320 --> 00:27:20,800 Speaker 1: It's you know, one thing. I mean, there's a lot 515 00:27:20,880 --> 00:27:26,280 Speaker 1: to unpack, obviously, but this, this topic seems like such 516 00:27:26,280 --> 00:27:30,679 Speaker 1: a great way of looking at so much Wall Street history. 517 00:27:30,800 --> 00:27:34,480 Speaker 1: From it being strictly a sort of like personal driven 518 00:27:34,520 --> 00:27:37,600 Speaker 1: business too, then the rise of the mathematics too, then 519 00:27:38,119 --> 00:27:42,240 Speaker 1: the software driven It seems like by examining this, we 520 00:27:42,320 --> 00:27:44,880 Speaker 1: really get this sort of pretty big scope of how 521 00:27:44,920 --> 00:27:47,320 Speaker 1: things have changed over the last several decades. Yeah, and 522 00:27:47,359 --> 00:27:49,480 Speaker 1: I think one of the really interesting things that Emmanuel 523 00:27:49,520 --> 00:27:51,720 Speaker 1: pointed out towards the end of the conversation was that 524 00:27:51,840 --> 00:27:55,199 Speaker 1: even though we essentially just recorded a podcast that was 525 00:27:55,240 --> 00:27:59,440 Speaker 1: sort of about physics and mathematical models and quantitative finance, 526 00:27:59,800 --> 00:28:02,800 Speaker 1: so much of it actually has to do with human 527 00:28:02,920 --> 00:28:06,920 Speaker 1: behavior and how traders and investors and people on Wall 528 00:28:06,920 --> 00:28:11,040 Speaker 1: Street choose to use those models. And uh, you know, 529 00:28:11,119 --> 00:28:14,359 Speaker 1: we've seen in the past that sometimes it goes horribly wrong, 530 00:28:14,400 --> 00:28:17,000 Speaker 1: and sometimes they do have a lot of practical use. 531 00:28:17,040 --> 00:28:22,520 Speaker 1: So I find that fascinating. And sometimes people's emotions just 532 00:28:22,720 --> 00:28:25,840 Speaker 1: make them cause them to make horrible decisions, even though 533 00:28:26,240 --> 00:28:29,560 Speaker 1: everything that intellectually or their models would say, uh, would 534 00:28:29,560 --> 00:28:32,760 Speaker 1: have advised against it exactly. And you know what, Joe, 535 00:28:32,800 --> 00:28:35,560 Speaker 1: this was actually a really timely discussion to have, given 536 00:28:35,960 --> 00:28:39,000 Speaker 1: the market fallout from Brexit and all the discussion we've 537 00:28:39,040 --> 00:28:43,360 Speaker 1: seen once again about var shocks and things that aren't 538 00:28:43,400 --> 00:28:47,640 Speaker 1: supposed to be happening mathematically happening once again, it was 539 00:28:47,680 --> 00:28:50,200 Speaker 1: a really timely discussion. I liked it. Yeah, you've written 540 00:28:50,360 --> 00:28:53,840 Speaker 1: so much about. That's a recurring theme of your writing 541 00:28:53,960 --> 00:28:56,000 Speaker 1: is how these things that are supposed to only happen 542 00:28:56,040 --> 00:28:58,240 Speaker 1: once every million years seemed to happen a few times 543 00:28:58,240 --> 00:29:02,680 Speaker 1: a year these days. Yeah, exactly, And unfortunately the models 544 00:29:03,240 --> 00:29:06,720 Speaker 1: aren't really well suited to taking that into account, so 545 00:29:07,040 --> 00:29:09,280 Speaker 1: we'll see what happens. All right. Well, this has been 546 00:29:09,320 --> 00:29:13,120 Speaker 1: another edition of the Odd Lots Podcast. I'm Joe Wisntal. 547 00:29:13,200 --> 00:29:15,600 Speaker 1: You can follow me on Twitter at the Stalwart, and 548 00:29:15,640 --> 00:29:18,760 Speaker 1: I'm Tracy Alloway. I'm on Twitter at Tracy Alloway. And 549 00:29:19,040 --> 00:29:22,640 Speaker 1: you should follow Emmanuel Derman on Twitter at Emmanuel Derman. 550 00:29:22,760 --> 00:29:25,160 Speaker 1: All Right, thanks for listening. We'll see you here next week.