1 00:00:07,480 --> 00:00:11,520 Speaker 1: Hello, and welcome to another episode of the Odd Lots Podcast. 2 00:00:11,640 --> 00:00:15,440 Speaker 1: I'm Joe Wisenthal, Managing editor at Bloomberg Markets, and I'm 3 00:00:15,480 --> 00:00:19,279 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 --> 00:00:26,840 Speaker 1: tell me what that I can read a book or 6 00:00:26,880 --> 00:00:30,880 Speaker 1: read an article and then two days later say, hey, 7 00:00:30,920 --> 00:00:33,680 Speaker 1: we should have the author of that in that article 8 00:00:33,840 --> 00:00:36,879 Speaker 1: or book on to discuss that, and we can do that. 9 00:00:37,000 --> 00:00:38,879 Speaker 1: I think that's a really cool thing. Is this podcast 10 00:00:38,920 --> 00:00:41,600 Speaker 1: going to become like Joe's book Club? It's basically going 11 00:00:41,640 --> 00:00:45,040 Speaker 1: to become Yeah, basically it's gonna be just here's what 12 00:00:45,159 --> 00:00:47,360 Speaker 1: Joe read the week before and wants to talk more about. 13 00:00:47,920 --> 00:00:50,440 Speaker 1: You know, but I, well, I can live. Yeah, it 14 00:00:50,520 --> 00:00:53,400 Speaker 1: won't be that bad. I read good stuff. But uh so, 15 00:00:53,440 --> 00:00:56,120 Speaker 1: I recently had the chance to read the book My 16 00:00:56,200 --> 00:00:59,680 Speaker 1: Life as a quant by Emmanuel Derman, who was a 17 00:00:59,720 --> 00:01:04,679 Speaker 1: physic assist theoretical physicist who eventually joined Wall Street during 18 00:01:04,720 --> 00:01:09,399 Speaker 1: the quantitative revolution and sort of was at all you know, 19 00:01:09,400 --> 00:01:11,800 Speaker 1: all these sort of there's so much talk about the 20 00:01:11,880 --> 00:01:16,240 Speaker 1: equations and models that run finance these days, and he 21 00:01:16,400 --> 00:01:20,080 Speaker 1: was at the ground floor of how that all got 22 00:01:20,120 --> 00:01:23,480 Speaker 1: built up. Oh well, that's exciting. We've talked plenty about 23 00:01:23,840 --> 00:01:27,560 Speaker 1: mathematical models and their role in finance on this podcast before, 24 00:01:27,720 --> 00:01:32,120 Speaker 1: so exactly so, why not? Exactly so? Why not talked 25 00:01:32,160 --> 00:01:35,400 Speaker 1: to one of the very original practitioners of it. And 26 00:01:35,440 --> 00:01:39,080 Speaker 1: we have Emmanuel here in studio, So um, I say, 27 00:01:39,160 --> 00:01:42,440 Speaker 1: let's get started. Let's do it. Emmanuel, thanks for joining us, 28 00:01:42,720 --> 00:01:45,280 Speaker 1: my pleasure. I'm really glad to be here. So I 29 00:01:45,280 --> 00:01:47,840 Speaker 1: want to start with something in your book. One of 30 00:01:47,880 --> 00:01:50,800 Speaker 1: the things that really struck me was you pointed out 31 00:01:50,960 --> 00:01:57,240 Speaker 1: how the explosion of exotic equity derivatives was very much 32 00:01:57,320 --> 00:02:01,640 Speaker 1: tied to the globalization of fine nand after the Cold 33 00:02:01,640 --> 00:02:04,800 Speaker 1: War ended. And there's really seemed like a poignant thing 34 00:02:04,880 --> 00:02:08,480 Speaker 1: to read right now after the Brexit vote, when it 35 00:02:08,560 --> 00:02:13,560 Speaker 1: feels like the world is arguably deglobalizing a little bit. 36 00:02:13,720 --> 00:02:17,480 Speaker 1: Finance seems to be in retreat. But explain to us 37 00:02:17,600 --> 00:02:20,120 Speaker 1: the connection there, because I thought that that was something 38 00:02:20,760 --> 00:02:23,480 Speaker 1: that I had never thought of until I read your book. Yeah, 39 00:02:23,560 --> 00:02:25,840 Speaker 1: that's very interesting. It's funny. Nobody's ever mentioned that to 40 00:02:25,840 --> 00:02:30,040 Speaker 1: me about my book before I joined them. Equity derivatives 41 00:02:30,120 --> 00:02:32,360 Speaker 1: at Goldman. I've been in fixed income. I joined Equit 42 00:02:32,360 --> 00:02:35,640 Speaker 1: Derivatives in early and I was in charge of the 43 00:02:35,720 --> 00:02:40,520 Speaker 1: quantitative Strategies group and we basically supported the options disc 44 00:02:40,639 --> 00:02:44,480 Speaker 1: And there was this flowering of interest in exotic options 45 00:02:44,560 --> 00:02:47,720 Speaker 1: because and it was because of globalization. Essentially, once the 46 00:02:47,720 --> 00:02:51,280 Speaker 1: Berlin Wall came down, people wanted to invest in foreign 47 00:02:51,560 --> 00:02:55,160 Speaker 1: in foreign stock markets. They didn't want to buy individual stocks, 48 00:02:55,200 --> 00:02:57,639 Speaker 1: so they used options, which was much simpler. There were 49 00:02:57,720 --> 00:03:00,280 Speaker 1: indicas developed all over the world, from the neck to 50 00:03:00,360 --> 00:03:03,359 Speaker 1: the keck to the decks, and everybody went to the 51 00:03:03,400 --> 00:03:05,480 Speaker 1: part of it. And there was also this fashion in 52 00:03:05,520 --> 00:03:08,200 Speaker 1: finance forum. Well it's still going on for sort of 53 00:03:08,200 --> 00:03:10,240 Speaker 1: not just buying your own country, not just buying the 54 00:03:10,240 --> 00:03:14,240 Speaker 1: stock of your own company. Canadian actually, Canadian pension funds 55 00:03:14,360 --> 00:03:16,800 Speaker 1: used to come to US because Canadian pension funds weren't 56 00:03:16,840 --> 00:03:19,720 Speaker 1: allowed to buy more than a small amount of foreign stock, 57 00:03:19,760 --> 00:03:22,280 Speaker 1: and so they would do their exposure through derivatives. Yes, 58 00:03:22,400 --> 00:03:24,720 Speaker 1: so explain that a little bit more. I think people 59 00:03:24,919 --> 00:03:29,239 Speaker 1: understand what essentially an option is, but explain, well, why 60 00:03:29,240 --> 00:03:31,960 Speaker 1: are they called exotic options and why do they have 61 00:03:32,080 --> 00:03:36,200 Speaker 1: an important role in giving people this international exposure Okay, 62 00:03:36,240 --> 00:03:39,000 Speaker 1: I'm glad you're asking that. No nobody have asked it before. 63 00:03:39,120 --> 00:03:42,240 Speaker 1: The Well, an option is the right, but not the obligation, 64 00:03:42,320 --> 00:03:44,760 Speaker 1: to buy something for a certain price in the future. So, 65 00:03:44,840 --> 00:03:48,200 Speaker 1: for example, you might have have the right to buy 66 00:03:48,200 --> 00:03:50,600 Speaker 1: IBM a ar from today at a hundred dollars or 67 00:03:50,600 --> 00:03:52,680 Speaker 1: whatever it is, and if IBM s trading above a 68 00:03:52,720 --> 00:03:54,840 Speaker 1: hundred dollars at that point, you can buy it for 69 00:03:54,880 --> 00:03:56,520 Speaker 1: a hundred dollars, sell it for a hundred and ten 70 00:03:56,560 --> 00:03:58,480 Speaker 1: if it's trading on hundred and ten, and make ten bucks. 71 00:03:58,480 --> 00:04:01,840 Speaker 1: And that's what people call vanilla standard call, And there's 72 00:04:01,840 --> 00:04:05,600 Speaker 1: a put similarly, but with exotic options. They allowed you 73 00:04:05,640 --> 00:04:09,400 Speaker 1: to get a much more fine tuned exposure to different things. So, 74 00:04:09,480 --> 00:04:11,960 Speaker 1: for example, the first thing I worked on, which was 75 00:04:12,040 --> 00:04:14,800 Speaker 1: kind of famous, not not me individally, but a Goldman, 76 00:04:15,240 --> 00:04:18,680 Speaker 1: was something called the Nike U the Nike put options, 77 00:04:18,720 --> 00:04:21,719 Speaker 1: where Goldman issued puts on the Nike and the nick 78 00:04:21,960 --> 00:04:23,600 Speaker 1: was trading at I don't remember it was that it's 79 00:04:23,600 --> 00:04:25,799 Speaker 1: all time high of like twenty nine thousand or something 80 00:04:25,839 --> 00:04:27,440 Speaker 1: like that. And there are a lot of people who 81 00:04:27,440 --> 00:04:29,640 Speaker 1: were skeptical about the future of Japan. Rightly as it 82 00:04:29,680 --> 00:04:33,680 Speaker 1: turns out and Goldman sold puts on the Nike. But 83 00:04:34,200 --> 00:04:36,720 Speaker 1: the reason they were exotic was people wanted a bet 84 00:04:36,720 --> 00:04:38,560 Speaker 1: than 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 NICK might go down, but the 87 00:04:43,480 --> 00:04:45,640 Speaker 1: end might strengthen, and so you wouldn't make any money 88 00:04:45,640 --> 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 00:04:52,320 --> 00:04:54,560 Speaker 1: in a guaranteed exchange rate. It didn't matter what the 91 00:04:54,640 --> 00:04:58,120 Speaker 1: yen dollar did. When you exercise your option, you got 92 00:04:58,120 --> 00:05:01,800 Speaker 1: paid in dollars the amount that the unique dropped in percent. 93 00:05:01,960 --> 00:05:04,200 Speaker 1: It was a put am I making sense. So that 94 00:05:04,279 --> 00:05:07,520 Speaker 1: was exotic because so in other words, it's not just 95 00:05:07,560 --> 00:05:11,480 Speaker 1: a planet, it's not a plane embedded in it. Are 96 00:05:11,600 --> 00:05:16,000 Speaker 1: more scenarios and more hedges, yes, or actually less in 97 00:05:16,040 --> 00:05:18,240 Speaker 1: a sense. You if you bought an ordery put on 98 00:05:18,240 --> 00:05:20,560 Speaker 1: the Nick, you would be exposed to both the yen 99 00:05:20,680 --> 00:05:23,159 Speaker 1: dollar and to the Nike, and this way you remove 100 00:05:23,200 --> 00:05:25,760 Speaker 1: the end dollar. So people would do this kind of stuff, 101 00:05:25,839 --> 00:05:29,160 Speaker 1: or people would buy knockout options, which were very popular, 102 00:05:29,279 --> 00:05:32,120 Speaker 1: which is an option that gives you money if it's 103 00:05:32,160 --> 00:05:35,599 Speaker 1: called gives you money if the stock rises, but gets 104 00:05:35,920 --> 00:05:37,800 Speaker 1: knocked out if the stock drops too low, if the 105 00:05:37,800 --> 00:05:40,000 Speaker 1: stock drops too high. All of these ways were basically 106 00:05:40,040 --> 00:05:44,960 Speaker 1: ways of making speculative bets. By putting up less money 107 00:05:44,960 --> 00:05:46,960 Speaker 1: than you would for vanial option, you were betting on 108 00:05:47,000 --> 00:05:49,840 Speaker 1: a smaller range of probabilities than just what was what 109 00:05:49,960 --> 00:05:53,599 Speaker 1: was reflected in an ordinary option. And Emmanuel, one thing 110 00:05:54,000 --> 00:05:56,440 Speaker 1: I always wonder about when it comes to these sorts 111 00:05:56,480 --> 00:05:59,880 Speaker 1: of exotic options and instruments is you're allowing me in 112 00:06:00,000 --> 00:06:03,760 Speaker 1: investor to sort of fine tune their risk. But how 113 00:06:03,800 --> 00:06:08,400 Speaker 1: do the banks that are actually offering these kind of products, 114 00:06:08,400 --> 00:06:11,400 Speaker 1: how did they manage their risk? Because things like knockout 115 00:06:11,440 --> 00:06:15,520 Speaker 1: options can be you know, um kind of painful for 116 00:06:15,600 --> 00:06:19,320 Speaker 1: the issuer, right, yes, So I mean that that was 117 00:06:19,360 --> 00:06:22,880 Speaker 1: my job exactly. We we Golden for example, issued these 118 00:06:22,920 --> 00:06:26,240 Speaker 1: exotic options, but if you sold them to somebody, you 119 00:06:26,240 --> 00:06:28,760 Speaker 1: didn't want to suffer when they made money. So you 120 00:06:28,800 --> 00:06:31,360 Speaker 1: had to head yourself. And you couldn't just buy an 121 00:06:31,360 --> 00:06:33,640 Speaker 1: exotic option from one person and sell it to another, 122 00:06:33,960 --> 00:06:37,760 Speaker 1: So you had to deconstructed and what black shoals and 123 00:06:37,800 --> 00:06:40,400 Speaker 1: all the extensions of option pricing do is tell you 124 00:06:41,000 --> 00:06:44,000 Speaker 1: essentially how to synthesize an option or an exotic option 125 00:06:44,120 --> 00:06:47,240 Speaker 1: from the underlying which is the currency and the and 126 00:06:47,320 --> 00:06:52,360 Speaker 1: the nique itself. Am I making sense? I'm not sure? No? Absolutely, Okay. 127 00:06:52,400 --> 00:06:54,719 Speaker 1: So so the models we worked on, which I did 128 00:06:54,760 --> 00:06:58,560 Speaker 1: for ten years, told you how to dynamically every day 129 00:06:58,720 --> 00:07:02,080 Speaker 1: trade the end dollar and every day trade the nika 130 00:07:02,600 --> 00:07:06,119 Speaker 1: in order to replicate what you were selling to somebody else. 131 00:07:06,200 --> 00:07:08,000 Speaker 1: You were selling them a package and now you had 132 00:07:08,120 --> 00:07:11,240 Speaker 1: created for yourself so that when they wont you wouldn't lose. Yeah. 133 00:07:11,240 --> 00:07:14,040 Speaker 1: I love the way in your book you essentially described 134 00:07:14,040 --> 00:07:20,600 Speaker 1: it as you're buying raw material, some combination of equity, cash, 135 00:07:20,760 --> 00:07:24,520 Speaker 1: the end, and then you're repackaging it and basically selling 136 00:07:24,520 --> 00:07:28,640 Speaker 1: it as a mark up like any other manufacturer done. Honestly, 137 00:07:28,680 --> 00:07:31,040 Speaker 1: that's what it is. You're you're a middleman, you're a 138 00:07:31,040 --> 00:07:35,160 Speaker 1: market maker, You're you're a wholesaler. You're buying complex stuff 139 00:07:35,200 --> 00:07:38,000 Speaker 1: that people want to sell, and you're decomposing it into 140 00:07:38,000 --> 00:07:42,559 Speaker 1: its constituents, or you're selling people complex stuff and making 141 00:07:42,560 --> 00:07:44,920 Speaker 1: it out of out of simple constituents. So it's really 142 00:07:45,160 --> 00:07:46,480 Speaker 1: I think, I say in my book, it's a bit 143 00:07:46,520 --> 00:07:48,440 Speaker 1: like fruit salad. If you want to know what you 144 00:07:48,440 --> 00:07:50,360 Speaker 1: should charge for fruit salad, you have to know the 145 00:07:50,360 --> 00:07:53,560 Speaker 1: cost of canning, the price of pears, apples, peaches, etcetera. 146 00:07:53,600 --> 00:07:55,760 Speaker 1: And then you you had a spread for your risk. 147 00:07:55,880 --> 00:07:58,720 Speaker 1: Because the models are really a little bit shaky. So 148 00:07:58,840 --> 00:08:01,640 Speaker 1: let's actually let's go back. Tell you you mentioned the 149 00:08:01,640 --> 00:08:06,120 Speaker 1: black skulls method, but tell us about your beginning on 150 00:08:06,240 --> 00:08:11,040 Speaker 1: Wall Street where quantitative finance was, and when you joined, 151 00:08:11,160 --> 00:08:13,400 Speaker 1: and then what you worked on in your earlier years. 152 00:08:13,520 --> 00:08:17,040 Speaker 1: You know, I came to Goldman, I've been a physicist 153 00:08:17,080 --> 00:08:19,120 Speaker 1: before that, and then I worked for five years of 154 00:08:19,240 --> 00:08:22,600 Speaker 1: the labs, where I already learned a lot of software engineering, 155 00:08:23,160 --> 00:08:26,960 Speaker 1: which was very useful, and I joined Goldman in and 156 00:08:27,240 --> 00:08:29,320 Speaker 1: the hot thing in those days interest rates were coming 157 00:08:29,360 --> 00:08:33,440 Speaker 1: down from the high of seventy nine. We've lived through 158 00:08:33,440 --> 00:08:36,520 Speaker 1: a massive bull market in bonds right now. And I 159 00:08:36,679 --> 00:08:40,280 Speaker 1: worked on black shoals explained how to price options on stock. 160 00:08:40,840 --> 00:08:43,880 Speaker 1: But now people were interested in buying options on bonds 161 00:08:44,400 --> 00:08:47,439 Speaker 1: because as interest rates came down, people wanted to speculate 162 00:08:47,480 --> 00:08:49,520 Speaker 1: on them going up again or going down again, and 163 00:08:49,600 --> 00:08:52,359 Speaker 1: so there was a big market and options on treasury bonds, 164 00:08:52,559 --> 00:08:55,120 Speaker 1: And the first thing I did was work with Fisher 165 00:08:55,200 --> 00:08:57,360 Speaker 1: Black and a colleague of mine, Bill Toy, on trying 166 00:08:57,360 --> 00:09:02,480 Speaker 1: to extend Black shoals into seeing yield curve things bonds 167 00:09:02,559 --> 00:09:06,080 Speaker 1: and bonds that paid coupons rather than stocks. And bonds 168 00:09:06,120 --> 00:09:09,440 Speaker 1: are very different from stocks because stocks have no termination date, 169 00:09:10,000 --> 00:09:13,200 Speaker 1: but bonds have a finite life, and and you really 170 00:09:13,240 --> 00:09:16,040 Speaker 1: need a totally different model, And I worked on something 171 00:09:16,040 --> 00:09:18,720 Speaker 1: called b d T everybody called it Black Dermon Toy, 172 00:09:18,760 --> 00:09:20,680 Speaker 1: which was one of the early models I did. That. 173 00:09:21,040 --> 00:09:23,480 Speaker 1: The world's gotten much more complicated since then. People make 174 00:09:23,559 --> 00:09:26,319 Speaker 1: much more elaborate models. So the way you describe the 175 00:09:26,360 --> 00:09:29,720 Speaker 1: eighties and the sort of explosion in exotic options, it 176 00:09:30,040 --> 00:09:33,800 Speaker 1: almost sounds like a sort of industrial revolution type thing 177 00:09:33,920 --> 00:09:37,840 Speaker 1: for the financial industry. Suddenly you have this big evolution 178 00:09:38,080 --> 00:09:41,680 Speaker 1: happening in products in ways to manage risk, and it 179 00:09:41,920 --> 00:09:45,400 Speaker 1: kind of leads to, um, I guess, more revenue and 180 00:09:45,840 --> 00:09:50,120 Speaker 1: growth of the financial industry as well. Yes, it was everybody. 181 00:09:50,320 --> 00:09:53,960 Speaker 1: It was a globalization. Um, it was the ability to 182 00:09:54,000 --> 00:09:58,200 Speaker 1: trade farm markets suddenly. Um it was Actually I wasn't 183 00:09:58,240 --> 00:10:01,160 Speaker 1: academic before. It was actually very excite. Everybody was waking 184 00:10:01,200 --> 00:10:03,480 Speaker 1: up every day to new products coming out and trying 185 00:10:03,480 --> 00:10:05,640 Speaker 1: to or your bank wanted to issue new products, and 186 00:10:05,679 --> 00:10:08,040 Speaker 1: you were trying to figure out how to value them 187 00:10:08,040 --> 00:10:10,480 Speaker 1: and hedge them because they want to eliminate as much 188 00:10:10,559 --> 00:10:13,320 Speaker 1: risk for themselves as possible. And so there was a 189 00:10:13,400 --> 00:10:15,800 Speaker 1: there was a Yeah, there was a literal sort of 190 00:10:16,559 --> 00:10:20,320 Speaker 1: efflorescence of papers on exotic options and how to hedge 191 00:10:20,360 --> 00:10:23,400 Speaker 1: volatility and the invention I worked on variant swaps, which 192 00:10:23,400 --> 00:10:28,000 Speaker 1: are ways of trading volatility rather than stocks. So how 193 00:10:28,000 --> 00:10:32,400 Speaker 1: did you feel about actually leaving physics and academia and 194 00:10:32,480 --> 00:10:36,200 Speaker 1: going to Wall Street because I imagine it must have 195 00:10:36,200 --> 00:10:39,600 Speaker 1: been quite a different work environment, right, Yes, I was. 196 00:10:40,160 --> 00:10:43,400 Speaker 1: I was very ashamed. You know, people who in physics, 197 00:10:43,480 --> 00:10:46,000 Speaker 1: and even I have colleagues today who are in physics, 198 00:10:46,000 --> 00:10:48,080 Speaker 1: they go into I wrote about this in my book. 199 00:10:48,080 --> 00:10:50,800 Speaker 1: They're going into physics a little bit like um with 200 00:10:50,880 --> 00:10:53,360 Speaker 1: a religious sort of fervor, thinking they're getting to discover 201 00:10:53,480 --> 00:10:57,840 Speaker 1: something fundamental, or try to discover something fundamental, and Um, 202 00:10:57,880 --> 00:11:01,200 Speaker 1: everybody looks down on you if you start to become practical, 203 00:11:01,320 --> 00:11:02,880 Speaker 1: if you start to go out to make a living. 204 00:11:03,440 --> 00:11:05,640 Speaker 1: We all despised people who did that, and eventually I 205 00:11:05,679 --> 00:11:09,680 Speaker 1: did that too. Yeah. I think one of the little 206 00:11:09,679 --> 00:11:12,319 Speaker 1: anecdotes in your book was about having some friend who 207 00:11:12,520 --> 00:11:15,120 Speaker 1: who went to work on traffic patterns in the city 208 00:11:15,200 --> 00:11:19,160 Speaker 1: and feeling sorry for him. Er. Yeah. Yeah. Even though 209 00:11:19,200 --> 00:11:21,199 Speaker 1: it sounds like interesting stuff, it is. One of the 210 00:11:21,280 --> 00:11:24,320 Speaker 1: lessons I've learned is that is that everything is interesting. 211 00:11:24,360 --> 00:11:26,080 Speaker 1: It's sort of like to see the world in a 212 00:11:26,080 --> 00:11:27,679 Speaker 1: grain of sand. If you look hard enough, then a 213 00:11:27,720 --> 00:11:30,520 Speaker 1: lot of things become interesting. But physics felt a bit 214 00:11:30,600 --> 00:11:32,439 Speaker 1: like a religion, and people look down on you when 215 00:11:32,440 --> 00:11:34,560 Speaker 1: you sort of left the monastery, and I felt that 216 00:11:34,600 --> 00:11:36,640 Speaker 1: for a while. I spent five years at Bell Labs, 217 00:11:36,679 --> 00:11:39,720 Speaker 1: which was interesting, but but it was my first experience 218 00:11:39,720 --> 00:11:41,920 Speaker 1: of working in a corporation and I sort of hated it. 219 00:11:42,440 --> 00:11:44,800 Speaker 1: And then when I came to gold to Wall Street 220 00:11:44,840 --> 00:11:47,240 Speaker 1: into Goldman, I actually loved it because they kind of 221 00:11:47,240 --> 00:11:50,120 Speaker 1: took an academic interest in this stuff, and so you 222 00:11:50,200 --> 00:11:53,960 Speaker 1: woke up every morning working on something interesting. But at 223 00:11:54,000 --> 00:11:57,160 Speaker 1: the same time there were people who really wanted it. Yeah. Actually, 224 00:11:57,320 --> 00:12:00,240 Speaker 1: I am one thing I still didn't quite understand. So 225 00:12:00,679 --> 00:12:05,319 Speaker 1: while you were working for Goldman, you also published papers 226 00:12:05,320 --> 00:12:09,680 Speaker 1: regularly and sort of publicized your findings how does that work? 227 00:12:09,720 --> 00:12:13,000 Speaker 1: The tension of wanting to have a model that allows 228 00:12:13,160 --> 00:12:17,760 Speaker 1: Goldman to profit while also wanting to do research that 229 00:12:18,040 --> 00:12:19,760 Speaker 1: the public can know about and you can have your 230 00:12:19,840 --> 00:12:23,079 Speaker 1: name attached to. Yeah, that's that's some I think that's 231 00:12:23,080 --> 00:12:25,880 Speaker 1: pretty much vanished. People on Wall Street, especially with Sabain's 232 00:12:25,920 --> 00:12:29,440 Speaker 1: Oxley passing ten or fifteen years ago, they they don't 233 00:12:29,440 --> 00:12:31,679 Speaker 1: publish much research anymore. But I grew up in an 234 00:12:31,679 --> 00:12:36,920 Speaker 1: era where people developed new things and unless somebody really 235 00:12:36,920 --> 00:12:39,720 Speaker 1: insisted that they were incredibly proprietary, like now, for example, 236 00:12:39,760 --> 00:12:43,760 Speaker 1: algorithmic trading, people people won't published papers on. But the 237 00:12:43,760 --> 00:12:46,880 Speaker 1: options business was by and large a sales business. You know, 238 00:12:47,080 --> 00:12:50,080 Speaker 1: you were making money not so much from speculating in volatility, 239 00:12:50,120 --> 00:12:54,280 Speaker 1: but from providing people services and and the more you 240 00:12:54,360 --> 00:12:56,920 Speaker 1: educated your clients, the better they understood what you were 241 00:12:56,920 --> 00:12:59,720 Speaker 1: trying to do. So it was a bit of a struggle, 242 00:12:59,760 --> 00:13:02,720 Speaker 1: but I worked for Fisher Black and I pushed quite hard. 243 00:13:02,760 --> 00:13:05,800 Speaker 1: We had a culture where where unless somebody it's sort out, 244 00:13:05,840 --> 00:13:08,560 Speaker 1: where you could never publish. And then it became for 245 00:13:08,640 --> 00:13:10,920 Speaker 1: a few years like they had to say you can't publish, 246 00:13:11,040 --> 00:13:14,480 Speaker 1: rather than you can publish. Did you ever get pushed 247 00:13:14,480 --> 00:13:19,360 Speaker 1: back from your employers, Goldman or someone else about I 248 00:13:19,360 --> 00:13:22,559 Speaker 1: guess the real world application of some of the stuff 249 00:13:22,559 --> 00:13:25,160 Speaker 1: you're doing, or its ability to generate money. Like if 250 00:13:25,160 --> 00:13:27,320 Speaker 1: you were working on a project and they couldn't exactly 251 00:13:27,360 --> 00:13:29,960 Speaker 1: see the commercial interest in it, would they ask you 252 00:13:30,000 --> 00:13:34,280 Speaker 1: to stop? Yeah, I mean, you know, I published a 253 00:13:34,280 --> 00:13:36,520 Speaker 1: lot of papers and I like doing that, and I 254 00:13:36,559 --> 00:13:38,640 Speaker 1: had a big group of people that did that, and 255 00:13:38,640 --> 00:13:40,800 Speaker 1: and sometimes actually contact me, and they said they didn't 256 00:13:40,840 --> 00:13:43,800 Speaker 1: realize what a rare environment it was, because most people 257 00:13:43,800 --> 00:13:46,319 Speaker 1: weren't allowed to do that. But we did that. But 258 00:13:46,360 --> 00:13:50,280 Speaker 1: at the same time, our real job was building risk 259 00:13:50,320 --> 00:13:53,800 Speaker 1: management systems for the people that traded equity derivatives, and 260 00:13:53,880 --> 00:13:56,080 Speaker 1: so I would say we sort of earned our keep 261 00:13:56,120 --> 00:13:59,360 Speaker 1: by building software that embedded these models and that let 262 00:13:59,360 --> 00:14:02,400 Speaker 1: them manage that positions. And at the same time we 263 00:14:02,400 --> 00:14:05,120 Speaker 1: had to build new models, and they moral less agreed 264 00:14:05,160 --> 00:14:07,560 Speaker 1: to let us publish, so they sometimes didn't like it. 265 00:14:08,600 --> 00:14:11,760 Speaker 1: One of the things that I found that maybe everybody 266 00:14:11,840 --> 00:14:14,240 Speaker 1: knew this before me, but that I did not know 267 00:14:14,360 --> 00:14:16,839 Speaker 1: until I read it in your book, was that the 268 00:14:18,000 --> 00:14:22,640 Speaker 1: seven stock market crash caused a permanent change to the 269 00:14:22,680 --> 00:14:26,760 Speaker 1: financial market landscape in terms of how options before that 270 00:14:26,800 --> 00:14:29,720 Speaker 1: crashed price in afterwards, and that had permanently changed the 271 00:14:29,720 --> 00:14:32,680 Speaker 1: way people value things. Can you explain what happened? Yes, 272 00:14:32,760 --> 00:14:35,440 Speaker 1: I can, um, and I'll make you writing a textbook. 273 00:14:35,600 --> 00:14:38,400 Speaker 1: I've just finished the textbook on that right now. But 274 00:14:38,400 --> 00:14:42,360 Speaker 1: but what happened in before seven? People pretty much used 275 00:14:42,400 --> 00:14:45,080 Speaker 1: the Black Sholes model to price options. Is it too 276 00:14:45,080 --> 00:14:48,640 Speaker 1: technical to talk about different strikes? Okay, with different strikes, 277 00:14:48,960 --> 00:14:50,800 Speaker 1: and they still use the same model and the tribute 278 00:14:50,800 --> 00:14:53,720 Speaker 1: to the same risk to the stock that lay underneath 279 00:14:53,800 --> 00:14:58,320 Speaker 1: the option. But after seven, 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 --> 00:15:04,360 Speaker 1: and from then on everybody being a bit anthropomorphic, but 282 00:15:04,400 --> 00:15:08,840 Speaker 1: everybody understood that markets tend to crash down and glide up, 283 00:15:09,040 --> 00:15:10,800 Speaker 1: which is kind of what's been happening here too. You 284 00:15:10,840 --> 00:15:13,480 Speaker 1: get a big move down, but you get slow moves up. 285 00:15:13,880 --> 00:15:16,040 Speaker 1: And so if the world is more likely to move 286 00:15:16,080 --> 00:15:18,880 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 00:15:21,040 --> 00:15:24,840 Speaker 1: the market drops. And everybody immediately did that, and it's 289 00:15:24,840 --> 00:15:27,720 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 --> 00:15:34,160 Speaker 1: was something that wasn't reflected in the market until seven. 292 00:15:34,200 --> 00:15:36,200 Speaker 1: I mean we had market we had stock market crashes 293 00:15:36,240 --> 00:15:38,840 Speaker 1: before then. Yeah, I guess there was no options market 294 00:15:38,880 --> 00:15:43,240 Speaker 1: in in nine. And the options market didn't really get 295 00:15:43,280 --> 00:15:47,040 Speaker 1: big until Black Black Controls published their paper in seventy three. 296 00:15:47,440 --> 00:15:50,040 Speaker 1: And yeah, there was a fourteen year period where where 297 00:15:50,120 --> 00:15:53,040 Speaker 1: people didn't worry too much about the stuff. And it's 298 00:15:53,040 --> 00:15:54,640 Speaker 1: been like that ever since. And in fact, the gold 299 00:15:54,680 --> 00:15:58,200 Speaker 1: market changed in the late nineties because central central banks 300 00:15:58,320 --> 00:16:01,800 Speaker 1: in some central in Switzerland did something other about gold, 301 00:16:01,840 --> 00:16:05,480 Speaker 1: and ever since then, gold tends to crash up when 302 00:16:05,480 --> 00:16:07,800 Speaker 1: the market goes down. Gold doesn't God, 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 00:16:10,320 --> 00:16:13,320 Speaker 1: get an inverse sort of option behavior that's been there since. 305 00:16:14,720 --> 00:16:17,720 Speaker 1: So all this talk about market crashes is kind of 306 00:16:17,800 --> 00:16:20,560 Speaker 1: reminding me of what's going on right now. In the 307 00:16:20,640 --> 00:16:24,320 Speaker 1: aftermath of the Brexit referendum in the UK. Um we 308 00:16:24,400 --> 00:16:27,120 Speaker 1: obviously saw market sell off after that, but we saw 309 00:16:27,160 --> 00:16:32,280 Speaker 1: a lot of people worrying about what systematic traders, uh, 310 00:16:32,400 --> 00:16:34,760 Speaker 1: you know, like risk parity guys that sort of thing 311 00:16:34,800 --> 00:16:37,520 Speaker 1: what they would do. And those guys have been likened 312 00:16:37,600 --> 00:16:42,560 Speaker 1: before to sort of modern portfolio insurers in the sense 313 00:16:43,000 --> 00:16:46,160 Speaker 1: that they could create this sort of feedback loop during 314 00:16:46,160 --> 00:16:48,440 Speaker 1: a big sell off. I'd love to get your thoughts 315 00:16:48,440 --> 00:16:51,120 Speaker 1: on that. I think that's true. I think anybody who 316 00:16:51,160 --> 00:16:56,240 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 00:16:59,320 --> 00:17:01,400 Speaker 1: try to dodge it. I mean, there's pretty people have 319 00:17:01,400 --> 00:17:03,520 Speaker 1: actually done very well in the best few months because 320 00:17:04,080 --> 00:17:09,399 Speaker 1: they like them they invest equally in in bonds, stocks 321 00:17:09,400 --> 00:17:11,760 Speaker 1: and commodities, and all of those things have gone up 322 00:17:12,840 --> 00:17:15,600 Speaker 1: so um. But yes, since they're behaving mechanically, there is 323 00:17:15,600 --> 00:17:18,760 Speaker 1: a danger that they keep doing the same thing. And 324 00:17:18,760 --> 00:17:20,960 Speaker 1: and you can only be clever if you're a small 325 00:17:21,000 --> 00:17:22,560 Speaker 1: part of the of the ocean. But if you're the 326 00:17:22,560 --> 00:17:25,160 Speaker 1: whole ocean, then then and everybody doing the same thing, 327 00:17:25,200 --> 00:17:30,200 Speaker 1: then your models don't work because you're actually affecting affecting 328 00:17:30,200 --> 00:17:32,200 Speaker 1: the thing you're trying to model. So yeah, I think 329 00:17:32,200 --> 00:17:35,800 Speaker 1: that could happen. Uh. You mentioned that part of the 330 00:17:35,840 --> 00:17:40,160 Speaker 1: reason you did the work earlier. Early on in your work, 331 00:17:40,440 --> 00:17:42,240 Speaker 1: there was a lot of demand for it because there 332 00:17:42,280 --> 00:17:44,720 Speaker 1: was a major shift in the direction of interest rates. 333 00:17:45,080 --> 00:17:47,480 Speaker 1: Right now, interest rates are only going in one direction. 334 00:17:47,560 --> 00:17:50,240 Speaker 1: Every day we wake up to new lower rates around 335 00:17:50,280 --> 00:17:54,440 Speaker 1: the world. Presumably one day that will change. It could 336 00:17:54,480 --> 00:17:57,560 Speaker 1: be next week, it could be years from now. When 337 00:17:57,600 --> 00:18:01,439 Speaker 1: that does happen, will we see once again lots of 338 00:18:01,480 --> 00:18:04,840 Speaker 1: models just being completely destroyed and types of portfolio is 339 00:18:04,880 --> 00:18:08,160 Speaker 1: not working and a sort of really really looking at 340 00:18:08,800 --> 00:18:11,440 Speaker 1: how to do all this stuff. That's I mean, I 341 00:18:11,440 --> 00:18:13,919 Speaker 1: think that's already happening. That's a perceptive question. If you 342 00:18:13,960 --> 00:18:15,960 Speaker 1: look at the thing I mentioned earlier, this Black Derman 343 00:18:16,000 --> 00:18:18,760 Speaker 1: toy model, and essentially all the interest rate models that 344 00:18:18,840 --> 00:18:21,320 Speaker 1: people built, they always assumed rates could never go negative. 345 00:18:21,640 --> 00:18:23,840 Speaker 1: If you try buying software, they actually won't let you 346 00:18:23,920 --> 00:18:26,880 Speaker 1: enter a negative rate. And so I don't really work 347 00:18:26,880 --> 00:18:28,800 Speaker 1: on this stuff anymore, but I think a lot of 348 00:18:28,800 --> 00:18:31,159 Speaker 1: people have been working for banks on how do you 349 00:18:31,320 --> 00:18:35,080 Speaker 1: value options when when there's actually a negative interest rate 350 00:18:35,080 --> 00:18:38,800 Speaker 1: which the previous model just didn't allow. And I mean, 351 00:18:39,160 --> 00:18:41,119 Speaker 1: this stuff is very different from physics. I try to 352 00:18:41,160 --> 00:18:43,000 Speaker 1: point out in my book because in physics, once you 353 00:18:43,000 --> 00:18:45,439 Speaker 1: figure out the way the planets work, they say that 354 00:18:45,480 --> 00:18:47,160 Speaker 1: way they don't really care what you say about them. 355 00:18:47,200 --> 00:18:49,280 Speaker 1: But when you figure out a model for markets and 356 00:18:49,320 --> 00:18:52,040 Speaker 1: everybody uses it, as Tracy was pointing out, it actually 357 00:18:52,040 --> 00:18:54,679 Speaker 1: starts to affect the thing you're modeling, and so no 358 00:18:54,800 --> 00:18:58,200 Speaker 1: model asks forever, you know, there's there's some It lives 359 00:18:58,200 --> 00:19:00,399 Speaker 1: for a while, and then people get smarter when market 360 00:19:00,720 --> 00:19:02,240 Speaker 1: which is what happened, and he said, when the market 361 00:19:02,280 --> 00:19:05,280 Speaker 1: suddenly misbehaves and they adjust their model, and it's it's 362 00:19:05,320 --> 00:19:07,560 Speaker 1: sort of an endless leap frog in a way. Well, 363 00:19:08,000 --> 00:19:10,159 Speaker 1: I suppose that gets to the heart of one of 364 00:19:10,160 --> 00:19:14,040 Speaker 1: the major criticisms leveled at quantitative finance and at models, 365 00:19:14,040 --> 00:19:17,200 Speaker 1: which is that how useful are they really? We hear 366 00:19:17,280 --> 00:19:20,680 Speaker 1: all the time about like ten sigma events in markets, 367 00:19:20,680 --> 00:19:22,719 Speaker 1: things that are only supposed to happen every you know, 368 00:19:23,200 --> 00:19:26,000 Speaker 1: one day in five million years, and things like that, 369 00:19:26,080 --> 00:19:29,919 Speaker 1: and they seem to keep happening. So clearly the models 370 00:19:29,920 --> 00:19:34,800 Speaker 1: are missing something, right, Yeah, you're right, I think. Yeah, 371 00:19:34,840 --> 00:19:36,879 Speaker 1: I've written a lot about the section. I think models 372 00:19:36,920 --> 00:19:39,840 Speaker 1: are only good as as long as the world stays 373 00:19:41,200 --> 00:19:43,480 Speaker 1: in the sort of regime that you're currently in, and 374 00:19:43,480 --> 00:19:45,680 Speaker 1: then they provide a good way of valuing things as 375 00:19:45,680 --> 00:19:47,760 Speaker 1: long as things change a little bit, not too much. 376 00:19:47,840 --> 00:19:50,080 Speaker 1: When you move to a new regime like negative interest 377 00:19:50,160 --> 00:19:53,720 Speaker 1: rates or this old central bank um sort of the 378 00:19:53,760 --> 00:19:56,520 Speaker 1: last seven years of risk on risk off, then your 379 00:19:56,560 --> 00:20:00,399 Speaker 1: old models don't work. And yeah, A kind of like 380 00:20:00,480 --> 00:20:02,880 Speaker 1: to say, it's idolatry to imagine that you can write 381 00:20:02,920 --> 00:20:06,440 Speaker 1: down an equation that's going to accurately reflect the way 382 00:20:06,480 --> 00:20:11,119 Speaker 1: people behave. Uh So let's sort of start or go 383 00:20:11,200 --> 00:20:13,080 Speaker 1: back to where we talked about in the beginning, with 384 00:20:13,119 --> 00:20:17,640 Speaker 1: the connection of globalization and exotic options. In the wake 385 00:20:17,720 --> 00:20:23,760 Speaker 1: of the Brexit vote, arguably finite the world maybe deglobalizing somewhat. 386 00:20:24,400 --> 00:20:27,800 Speaker 1: What is uh, what is your assessment of the financial 387 00:20:27,800 --> 00:20:30,040 Speaker 1: industry these days? Every day we wake up to news 388 00:20:30,119 --> 00:20:37,399 Speaker 1: about layoffs, retrenchments, large banks divesting their their foreign subsidiaries. 389 00:20:38,119 --> 00:20:42,159 Speaker 1: Where do you see the industry going? You know, it 390 00:20:42,200 --> 00:20:44,800 Speaker 1: goes in cycles. When I when I started out, it 391 00:20:44,960 --> 00:20:47,119 Speaker 1: was very important to be able to program and to 392 00:20:47,160 --> 00:20:50,399 Speaker 1: do quantitative work. Then at some point being able to 393 00:20:50,400 --> 00:20:52,879 Speaker 1: program became a commodity that you could give to the 394 00:20:52,880 --> 00:20:55,080 Speaker 1: I T people and you just did theoretical work, which 395 00:20:55,160 --> 00:20:59,120 Speaker 1: I never really liked. And now now exotic options are 396 00:20:59,320 --> 00:21:02,240 Speaker 1: sort of pretty much a small market. Nobody's interested in 397 00:21:02,280 --> 00:21:06,520 Speaker 1: that anymore. Everything's done electronically and algorithmically, and so software 398 00:21:06,560 --> 00:21:10,600 Speaker 1: skills for for financial companies and investment banks and for 399 00:21:10,680 --> 00:21:14,000 Speaker 1: hedge funds have become much more important. And so I'm 400 00:21:14,040 --> 00:21:16,160 Speaker 1: looking for the point of the job market students now. 401 00:21:16,320 --> 00:21:19,080 Speaker 1: Students now have to be good programmers if they want 402 00:21:19,080 --> 00:21:20,600 Speaker 1: to get a job, which didn't used to be the 403 00:21:20,600 --> 00:21:23,639 Speaker 1: case ten or fifteen years ago. So I think everything 404 00:21:23,680 --> 00:21:28,120 Speaker 1: is moving away from exoticism and towards vanilla products um 405 00:21:28,240 --> 00:21:34,480 Speaker 1: algorithmic trading, high frequency trading by computer. That's what it's 406 00:21:34,480 --> 00:21:36,040 Speaker 1: been like for the last five or six years, and 407 00:21:36,160 --> 00:21:38,600 Speaker 1: I don't see that ending soon. Does that make you 408 00:21:38,720 --> 00:21:42,520 Speaker 1: happy or sad? The idea that some of the exoticism 409 00:21:42,520 --> 00:21:45,800 Speaker 1: of Wall Street might be going away now A little 410 00:21:45,800 --> 00:21:47,760 Speaker 1: bit sad in the sense that I had a good time. 411 00:21:48,800 --> 00:21:50,520 Speaker 1: What was nice about the years that I worked at 412 00:21:50,520 --> 00:21:54,879 Speaker 1: Goldman was that Goldman functioned in a very informal and 413 00:21:55,000 --> 00:21:57,320 Speaker 1: bureaucratic way, at least for the first and for the 414 00:21:57,359 --> 00:21:59,160 Speaker 1: first ten years I was there, And if you worked 415 00:21:59,160 --> 00:22:02,040 Speaker 1: with the trading desk, it was a bit like being 416 00:22:02,040 --> 00:22:03,800 Speaker 1: in physics. There were a bunch of traders who are 417 00:22:03,800 --> 00:22:06,440 Speaker 1: like the experimentalists, and a bunch of quantity with the theorists, 418 00:22:06,440 --> 00:22:08,359 Speaker 1: and you all spoke every day and you work together, 419 00:22:08,720 --> 00:22:12,640 Speaker 1: and it was kind of exciting. And I think what's 420 00:22:12,640 --> 00:22:15,480 Speaker 1: said a little bit for me now is that most 421 00:22:15,560 --> 00:22:17,960 Speaker 1: of the jobs for people are in bureaucracy and risk 422 00:22:18,000 --> 00:22:24,440 Speaker 1: management and risk reporting, in basle regulations. And yeah, very 423 00:22:24,560 --> 00:22:28,280 Speaker 1: very um very driven by regulation and reporting rather than 424 00:22:28,800 --> 00:22:33,639 Speaker 1: actually trying to do new things. Is the regulation, while 425 00:22:33,640 --> 00:22:36,400 Speaker 1: it may be boring and not exciting, is it at 426 00:22:36,440 --> 00:22:38,280 Speaker 1: a good thing for society or do you think it 427 00:22:38,280 --> 00:22:41,600 Speaker 1: could be a counterproductive I think it's good up to 428 00:22:41,640 --> 00:22:44,159 Speaker 1: a point. But I'm a bit of a skeptic about 429 00:22:44,880 --> 00:22:46,520 Speaker 1: I'm a bit of a skeptic about what's happened in 430 00:22:46,560 --> 00:22:50,360 Speaker 1: the last ideas I think they should have. I think 431 00:22:50,359 --> 00:22:51,840 Speaker 1: that I think that the way people learn a good 432 00:22:51,920 --> 00:22:53,919 Speaker 1: lesson is when they go bankrupt, when they lost a 433 00:22:53,920 --> 00:22:56,520 Speaker 1: lot of money by being stupid, or by being careless, 434 00:22:56,600 --> 00:22:58,520 Speaker 1: or but just just by the fact that that's the 435 00:22:58,520 --> 00:23:02,639 Speaker 1: way the world works. And I think nothing's nothing prevents 436 00:23:02,680 --> 00:23:05,760 Speaker 1: people from doing bad things again except getting punished by 437 00:23:05,760 --> 00:23:09,280 Speaker 1: the market for having done them. And I think forty 438 00:23:09,680 --> 00:23:13,119 Speaker 1: page of regulation are are not an adequate substitute for 439 00:23:13,240 --> 00:23:18,000 Speaker 1: just letting people go under when they do badly? Easy 440 00:23:18,080 --> 00:23:24,119 Speaker 1: to say, I know, but but nevertheless, Uh so you 441 00:23:24,240 --> 00:23:28,600 Speaker 1: mentioned that you're working on a textbook. Let's what is that? 442 00:23:28,760 --> 00:23:32,960 Speaker 1: And also just what else are you interested in these days? Um, 443 00:23:33,040 --> 00:23:36,520 Speaker 1: I'm working. I taught a course on the volatility smile 444 00:23:36,560 --> 00:23:39,400 Speaker 1: on this thing that happens in seven for the last 445 00:23:39,440 --> 00:23:41,919 Speaker 1: ten or fifteen years, mostly based on the work I 446 00:23:42,000 --> 00:23:44,320 Speaker 1: did at Goldman, and so I've just finished a textbook 447 00:23:44,359 --> 00:23:46,080 Speaker 1: on that, which is coming out in September, and it 448 00:23:46,119 --> 00:23:48,760 Speaker 1: has a very pretty cover from I don't know even 449 00:23:48,760 --> 00:23:52,280 Speaker 1: know who hockey side was. He was some Spanish woodcutter 450 00:23:52,480 --> 00:23:54,080 Speaker 1: a picture of a big wave which looks like a 451 00:23:54,119 --> 00:24:00,000 Speaker 1: volatility smile. So I'm finished that. Um. I wrote another 452 00:24:00,000 --> 00:24:02,720 Speaker 1: book called Models Behaving Badly, which was more philosophical about 453 00:24:02,760 --> 00:24:04,800 Speaker 1: the difference between models and physics. And I kind of like, 454 00:24:05,160 --> 00:24:06,520 Speaker 1: I don't know, I've I've spent a lot of time 455 00:24:06,560 --> 00:24:10,280 Speaker 1: doing quantitative stuff. I prefer doing qualitative stuff and writing. Now. 456 00:24:11,880 --> 00:24:14,639 Speaker 1: Um there's actually I'm working a little bit with the 457 00:24:14,680 --> 00:24:18,000 Speaker 1: guy who's a professor of anthropology. This is kind of 458 00:24:18,040 --> 00:24:21,119 Speaker 1: interesting at at at the News School, and there are 459 00:24:21,119 --> 00:24:22,639 Speaker 1: a whole bunch of them who are very interested in 460 00:24:22,680 --> 00:24:25,680 Speaker 1: the anthropology of finance and the way traders behave. And 461 00:24:25,720 --> 00:24:28,880 Speaker 1: it's kind of interesting because traders use models that they 462 00:24:28,880 --> 00:24:31,840 Speaker 1: know are wrong, but nevertheless they keep using them in 463 00:24:31,880 --> 00:24:35,639 Speaker 1: a more or less effective way. And we're interested in 464 00:24:35,680 --> 00:24:38,520 Speaker 1: sort of looking at at at how this works. And 465 00:24:38,560 --> 00:24:41,800 Speaker 1: plus he's got this idea, which I think is right. 466 00:24:41,800 --> 00:24:45,240 Speaker 1: It's a little that that that volatility became an interesting 467 00:24:45,320 --> 00:24:48,320 Speaker 1: thing in society in the last fifteen in the last 468 00:24:48,359 --> 00:24:51,760 Speaker 1: thirty years. If you look at them, if you look 469 00:24:51,760 --> 00:24:55,400 Speaker 1: at people writing surfboards are doing skateboarding, they're actually doing 470 00:24:55,440 --> 00:24:58,679 Speaker 1: something very similar. When they go up and down, up 471 00:24:58,720 --> 00:25:03,680 Speaker 1: and down, they're sort of hedging out there there. Maybe 472 00:25:03,720 --> 00:25:07,399 Speaker 1: I'm getting to complicate this is okay. Well, when you 473 00:25:07,480 --> 00:25:10,760 Speaker 1: value an option, you first hedge it, and so you 474 00:25:10,880 --> 00:25:13,280 Speaker 1: get rid of the pure market risk and what you 475 00:25:13,400 --> 00:25:15,720 Speaker 1: left with is a sort of convexity kind of shape 476 00:25:15,760 --> 00:25:18,960 Speaker 1: that's just the residual part of the option. And it's 477 00:25:19,080 --> 00:25:21,399 Speaker 1: very similar in a in a metaphorical way to what 478 00:25:21,600 --> 00:25:25,840 Speaker 1: skateboarders or to what surfers do when they ride they 479 00:25:25,920 --> 00:25:28,960 Speaker 1: ride a wave, and they're not interested in the horizontal motion. 480 00:25:29,000 --> 00:25:30,879 Speaker 1: They're interested in moving up and down the curve of 481 00:25:30,920 --> 00:25:34,840 Speaker 1: the wave as it as it curls. And um, this 482 00:25:35,200 --> 00:25:37,640 Speaker 1: friend of mine is sort of interested in the whole 483 00:25:37,680 --> 00:25:41,200 Speaker 1: idea of people in the world since the early seventies 484 00:25:41,240 --> 00:25:45,000 Speaker 1: being interested in volatility as a as a as a quantity, 485 00:25:45,040 --> 00:25:47,359 Speaker 1: the same way as people use options to trade volatility 486 00:25:47,359 --> 00:25:50,200 Speaker 1: as an asset. So you know, people who wander through 487 00:25:50,240 --> 00:25:53,560 Speaker 1: city streets and try to experience the excitement rather than 488 00:25:53,600 --> 00:25:55,439 Speaker 1: trying to go somewhere. Is a is a sort of 489 00:25:55,560 --> 00:26:01,600 Speaker 1: version of of optionality. Interesting. Well, it sounds like fascinating stuff, 490 00:26:02,000 --> 00:26:04,320 Speaker 1: and I hope you are now. I really want to 491 00:26:04,359 --> 00:26:07,240 Speaker 1: read more about this stuff, and I hope you write 492 00:26:07,280 --> 00:26:09,680 Speaker 1: on it. Okay, Um, yeah, my textbook is going to 493 00:26:09,760 --> 00:26:12,560 Speaker 1: be a technical book, although I'm very against if I 494 00:26:12,600 --> 00:26:16,200 Speaker 1: can say one more thing, Um, finance and financial engineering 495 00:26:16,200 --> 00:26:19,440 Speaker 1: has gotten very mathematical in the last fifteen or twenty years, 496 00:26:19,440 --> 00:26:21,879 Speaker 1: and I kind of disapproved people teach it as though 497 00:26:21,920 --> 00:26:24,040 Speaker 1: it's a branch of mathematics, but really it's a real 498 00:26:24,040 --> 00:26:27,720 Speaker 1: world field and it shouldn't have theorems or axioms. It's 499 00:26:27,760 --> 00:26:30,480 Speaker 1: about the way the world behaves. And I'm I'm trying 500 00:26:30,480 --> 00:26:32,520 Speaker 1: to write my textbook in that way too, and a 501 00:26:32,560 --> 00:26:36,080 Speaker 1: little bit of a of a counter counterpoint to the 502 00:26:36,080 --> 00:26:39,119 Speaker 1: way that people people often teach finance. And now it's 503 00:26:39,119 --> 00:26:41,240 Speaker 1: a branch of pure math, as though you write down 504 00:26:41,240 --> 00:26:43,240 Speaker 1: axioms and you you know, like euclid, and you work 505 00:26:43,240 --> 00:26:45,880 Speaker 1: out the results, and the world doesn't really work that way. 506 00:26:46,040 --> 00:26:48,000 Speaker 1: And as you point out, all models are wrong. It's 507 00:26:48,040 --> 00:26:51,719 Speaker 1: just yes, which which ones are less wrong? Yes? All right, 508 00:26:51,840 --> 00:26:55,400 Speaker 1: Emmanuel German, author of My Life as a quant and 509 00:26:55,720 --> 00:26:58,359 Speaker 1: models are behaving badly and a forthcoming textbook on the 510 00:26:58,440 --> 00:27:01,560 Speaker 1: volatility smile. Thank you very much for joining us. Thanks 511 00:27:01,560 --> 00:27:07,400 Speaker 1: someone's glad to be here. Well, Tracy, I I loved 512 00:27:07,440 --> 00:27:10,760 Speaker 1: that discussion. I'm guessing you did too, me too, I 513 00:27:11,480 --> 00:27:15,560 Speaker 1: I gradgically admit I I will join the Joe Wisenthal 514 00:27:15,760 --> 00:27:19,680 Speaker 1: book Club in future. It's you know, one thing. I mean, 515 00:27:20,280 --> 00:27:25,320 Speaker 1: there's a lot to unpack, obviously, but this, this topic 516 00:27:25,520 --> 00:27:29,240 Speaker 1: seems like such a great way of looking at so 517 00:27:29,320 --> 00:27:32,880 Speaker 1: much Wall Street history from it being strictly a sort 518 00:27:32,880 --> 00:27:36,199 Speaker 1: of like personal driven business too. Then the rise of 519 00:27:36,280 --> 00:27:40,200 Speaker 1: the mathematics too, then the software driven. It seems like 520 00:27:40,680 --> 00:27:43,760 Speaker 1: by examining this we really get this sort of pretty 521 00:27:43,800 --> 00:27:46,080 Speaker 1: big scope of how things have changed over the last 522 00:27:46,119 --> 00:27:48,240 Speaker 1: several decades. Yeah, and I think one of the really 523 00:27:48,280 --> 00:27:50,800 Speaker 1: interesting things that Emmanuel pointed out towards the end of 524 00:27:50,800 --> 00:27:54,320 Speaker 1: the conversation was that even though we essentially just recorded 525 00:27:54,320 --> 00:27:57,680 Speaker 1: a podcast that was sort of about physics and mathematical 526 00:27:57,760 --> 00:28:01,440 Speaker 1: models and quantitative finance, so oh, much of it actually 527 00:28:01,520 --> 00:28:05,199 Speaker 1: has to do with human behavior and how traders and 528 00:28:05,240 --> 00:28:09,600 Speaker 1: investors and people on Wall Street choose to use those models. 529 00:28:10,160 --> 00:28:12,080 Speaker 1: And uh, you know, we've seen in the past that 530 00:28:12,200 --> 00:28:15,919 Speaker 1: sometimes it goes horribly wrong, and sometimes they do have 531 00:28:15,960 --> 00:28:18,800 Speaker 1: a lot of practical use. So I find that fascinating. 532 00:28:19,800 --> 00:28:23,920 Speaker 1: And sometimes people's emotions just make them cause them to 533 00:28:24,000 --> 00:28:27,960 Speaker 1: make horrible decisions, even though everything that intellectually or their 534 00:28:27,960 --> 00:28:31,560 Speaker 1: models would say, uh, would have advised against it exactly. 535 00:28:31,720 --> 00:28:33,760 Speaker 1: And you know what, Joe, this was actually a really 536 00:28:33,800 --> 00:28:37,600 Speaker 1: timely discussion to have, given the market fallout from Brexit 537 00:28:37,760 --> 00:28:41,200 Speaker 1: and all the discussion we've seen once again about var 538 00:28:41,400 --> 00:28:45,280 Speaker 1: shocks and things that aren't supposed to be happening mathematically 539 00:28:45,400 --> 00:28:49,000 Speaker 1: happening once again, it was a really timely discussion. I 540 00:28:49,040 --> 00:28:52,360 Speaker 1: liked it. Yeah, you've written so much about That's a 541 00:28:52,400 --> 00:28:54,960 Speaker 1: recurring theme of your writing is how these things that 542 00:28:55,000 --> 00:28:57,400 Speaker 1: are supposed to only happen once every million years seemed 543 00:28:57,400 --> 00:29:01,160 Speaker 1: to happen a few times a year these days. Yeah, exactly. 544 00:29:01,200 --> 00:29:05,360 Speaker 1: And unfortunately the models aren't really well suited to taking 545 00:29:05,400 --> 00:29:08,840 Speaker 1: that into account, so we'll see what happens. All right, Well, 546 00:29:08,880 --> 00:29:12,040 Speaker 1: this has been another edition of the Odd Lots Podcast. 547 00:29:12,120 --> 00:29:14,640 Speaker 1: I'm Joe Wisnthal. You can follow me on Twitter at 548 00:29:14,640 --> 00:29:17,520 Speaker 1: the Stalwart, and I'm Tracy Alloway. I'm on Twitter at 549 00:29:17,560 --> 00:29:21,480 Speaker 1: Tracy Alloway. And you should follow Emmanuel Derman on Twitter 550 00:29:21,640 --> 00:29:24,480 Speaker 1: at Emmanuel Derma. All Right, thanks for listening. We'll see 551 00:29:24,520 --> 00:29:25,960 Speaker 1: you here next week.