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Here's the important part of the article: There are skeptics, too. Emanuel Derman, who was among the first physicists to work on Wall Street, doubts that biolo

Here's the important part of the article: There are skeptics, too. Emanuel Derman, who was among the first physicists to work on Wall Street, doubts that biologists possess secret sauce for investing. Derman rose to lead the quant risk strategies group in his 17 years at Goldman Sachs Group Inc. He found that as physicists applied their expertise of the laws of motion, atoms and mathematics to investing, their models didn’t work nearly as well as they did in a lab. Newton’s law of gravity hasn’t changed for eons, Derman said, but human behavior in markets changes all the time, wreaking havoc on even the best models made by scientists. “I’ve developed a lot of skepticism about anyone bringing their expertise from one field to another,” said Derman, author of the book “Models.Behaving.Badly” and a Columbia University professor of financial engineering. “They say stocks are like atoms, or like genes. But stocks are not atoms or genes. There is a resemblance, but ultimately they are very different.”

redroot9 9y ago
This is essentially a certain type of cognitive bias I think (halo effect?), where people take someone's high skill or talent in one area and assume it carries to another field. For example, assuming a chess grandmaster will be good at business strategy, or a great mathematician an automatically great engineer. These examples are convaluted but anecdotally I've seen it in action in recruiting. Also 'the map is not the territory', all models will be unable to deal with all possible behaviours of the reality they are dealing with in a correct way.
- dsacco 9y ago
  I don't think the cognitive bias you're describing matches this scenario very well, because that bias appears to result when people don't acknowledge specialization versus overall intelligence. Your first example seems like it maps well to that cognitive bias - someone assumes that a chess grandmaster has catch-all capability because they demonstrated expertise in one area, and then they flare out in an orthogonal area. Mathematics and engineering (at least, computer science) overlap in many areas. If someone excels at mathematics it doesn't prove that they'd be good at programming, but I'd bet a significant amount of money that the mean mathematics major is more capable of programming than the mean population in general. If that holds, there's no bias in trying to cross-pollinate expertise, even if it ultimately doesn't work out. A lot of the work that occurs in finance is legitimate mathematics and has very close ties to physics. The heat equation is directly used in Black-Scholes; securities can be modeled as stochastic processes, which means that much of the models that apply to Brownian motion also apply to them. Outside of quantitative derivatives pricing (and more recently), hedge funds can apply the same scientific computing techniques used by physicists and computational biologists to analyze vast amounts of data (more than they know what to do with).
  - computerex 9y ago
    And yet: http://fortune.com/2016/05/11/warren-buffett-hedge-fund-bet/ http://fortune.com/2016/05/11/warren-buffett-hedge-fund-bet/
    - dsacco 9y ago
      1. That doesn't meaningfully respond to my point about cross pollinating skillsets, because we aren't distinguishing between amateurs, novices who become professionaks after expertise in other fields, and core professionals in finance/economics. 2. That bet is paraded more than it should be. Buffett bet against a "fund of funds", which is the aggregate performance of the industry. We didn't need a decade long bet to tell us most hedge funds are a poor return of capital, just as we don't need a bet to realize that the greatest n participants in many fields are mediocre. I would have gladly taken that bet with Buffett and won if I could have chosen a single firm. But Buffett wouldn't have taken that bet, because (to his credit) he understands this point already as a savvy investor. The bet proves that the industry overall is mediocre, but it says nothing about the top firms that mostly don't even take outside capital anymore because they're so successful.
      - computerex 9y ago
        I was being cheeky when I responded to you. I agree with you on the first point. But I think you are downplaying the significance of the bet. If it was an obvious wash like you are making it seem then why was the bet even placed? What top firms are you talking about?
        dsacco 9y ago
        1. The bet was placed because Buffett's thesis is fundamentally true - you have much better odds of receiving a good return through passive index fund investing than you do through active management. However, this bet is often used (unempirically, though not necessarily strictly inaccurately) to justify the idea that active management cannot beat the market consistently. 2. Firms like Baupost or RenTec would have handily won that bet against Buffett. But like I said, Buffett wouldn't have made that bet, because Buffett is a smart better and already knows all of this. Buffett has never argued that the market is perfectly efficient and resistant to alpha harvesting; in fact, he has publicly taken the opposite position in letters to shareholders.
ice109 9y ago
I asked derman what an alternative would be to the formal models quants use now and his answer was that the whole thing should just be left up to "smart people and their gut instincts". the problem is that as soon as these smart people's gut instincts fail (which they will) and they try to investigate why you'll be right back to formal models. derman strikes me as just a guy trying to sell books.

redroot9 9y ago

This is essentially a certain type of cognitive bias I think (halo effect?), where people take someone's high skill or talent in one area and assume it carries to another field. For example, assuming a chess grandmaster will be good at business strategy, or a great mathematician an automatically great engineer. These examples are convaluted but anecdotally I've seen it in action in recruiting. Also 'the map is not the territory', all models will be unable to deal with all possible behaviours of the reality they are dealing with in a correct way.

dsacco 9y ago
I don't think the cognitive bias you're describing matches this scenario very well, because that bias appears to result when people don't acknowledge specialization versus overall intelligence. Your first example seems like it maps well to that cognitive bias - someone assumes that a chess grandmaster has catch-all capability because they demonstrated expertise in one area, and then they flare out in an orthogonal area. Mathematics and engineering (at least, computer science) overlap in many areas. If someone excels at mathematics it doesn't prove that they'd be good at programming, but I'd bet a significant amount of money that the mean mathematics major is more capable of programming than the mean population in general. If that holds, there's no bias in trying to cross-pollinate expertise, even if it ultimately doesn't work out. A lot of the work that occurs in finance is legitimate mathematics and has very close ties to physics. The heat equation is directly used in Black-Scholes; securities can be modeled as stochastic processes, which means that much of the models that apply to Brownian motion also apply to them. Outside of quantitative derivatives pricing (and more recently), hedge funds can apply the same scientific computing techniques used by physicists and computational biologists to analyze vast amounts of data (more than they know what to do with).
- computerex 9y ago
  And yet: http://fortune.com/2016/05/11/warren-buffett-hedge-fund-bet/ http://fortune.com/2016/05/11/warren-buffett-hedge-fund-bet/
  - dsacco 9y ago
    1. That doesn't meaningfully respond to my point about cross pollinating skillsets, because we aren't distinguishing between amateurs, novices who become professionaks after expertise in other fields, and core professionals in finance/economics. 2. That bet is paraded more than it should be. Buffett bet against a "fund of funds", which is the aggregate performance of the industry. We didn't need a decade long bet to tell us most hedge funds are a poor return of capital, just as we don't need a bet to realize that the greatest n participants in many fields are mediocre. I would have gladly taken that bet with Buffett and won if I could have chosen a single firm. But Buffett wouldn't have taken that bet, because (to his credit) he understands this point already as a savvy investor. The bet proves that the industry overall is mediocre, but it says nothing about the top firms that mostly don't even take outside capital anymore because they're so successful.
    - computerex 9y ago
      I was being cheeky when I responded to you. I agree with you on the first point. But I think you are downplaying the significance of the bet. If it was an obvious wash like you are making it seem then why was the bet even placed? What top firms are you talking about?
      - dsacco 9y ago
        1. The bet was placed because Buffett's thesis is fundamentally true - you have much better odds of receiving a good return through passive index fund investing than you do through active management. However, this bet is often used (unempirically, though not necessarily strictly inaccurately) to justify the idea that active management cannot beat the market consistently. 2. Firms like Baupost or RenTec would have handily won that bet against Buffett. But like I said, Buffett wouldn't have made that bet, because Buffett is a smart better and already knows all of this. Buffett has never argued that the market is perfectly efficient and resistant to alpha harvesting; in fact, he has publicly taken the opposite position in letters to shareholders.

ice109 9y ago

I asked derman what an alternative would be to the formal models quants use now and his answer was that the whole thing should just be left up to "smart people and their gut instincts". the problem is that as soon as these smart people's gut instincts fail (which they will) and they try to investigate why you'll be right back to formal models. derman strikes me as just a guy trying to sell books.