5 ms·

There is kind of an odd tone to this article as if the shrinking of the quant economy is a tragedy when in fact it should be the natural course of this sector i

There is kind of an odd tone to this article as if the shrinking of the quant economy is a tragedy when in fact it should be the natural course of this sector if it is not too corrupted. The efficient market hypothesis and information theory tells us that using probabilistic models to extract a competitive advantage can only give good returns when your method is better than all of your competitors'. When two firms have similarly optimized tactics, they bet against each other and the margin of money than can be skimmed off their betting market will shrink to almost nothing. I don't mean that the profits will be split between the two. I mean the bidding war will push the price towards its optimal value where no money can be extracted. In a competitive quant market, as all the firms perfect their mathematical models, they should all move asymptotically towards the best probabilistic model possible given the available information and eventually erase each other's gains. The boom in computing technology of the past thirty years was an immense opportunity for mathematicians to make money by racing to perfect their models before others. However, as this industry matures it should eventually take only a few very good systems to extract a thin margin that will barely cover the cost of running the systems themselves. Moving towards that point of efficiency is a capitalist and libertarian victory that people (at least those who believe in capitalism) should celebrate. The conclusion is a market so efficient that little money can be extracted by betting in it. That means money going to the real economy instead of the wall street casino and more value for everyone. The fact that the sector is shrinking indicates the free market is actually working. I don't believe in the free market everywhere but I think when it actually works well and create value we should be glad, not lament the loss of the casino profits. This allegory illustrates the efficient market hypothesis nicely: http://agoraphilia.blogspot.com/2005/03/doing-lines.html http://agoraphilia.blogspot.com/2005/03/doing-lines.html

joshu 16y ago
Yes. There's been a huge hedge fund boom for years, and it'd been buoyed by the rising market. (a proper hedge fund ought to be uncorrelated to the market, else it would be cheaper to go long the market more directly. But I digress) This is the natural evolution of an underperforming asset class.
- SkyMarshal 16y ago
  Yes, 'hedge' fund is (a probably intentionally) amusing misnomer.
secretasiandan 16y ago
1) There will always be non-professionals/non-quantitative people making trades that create potential profit for those who wish to arb them. 2) You can still make "good" returns even when you have the worst of the models because of 1). 3) It takes more than N>>2 firms to shrink the profit in a particular model to 0. For evidence, see the large number of high frequency funds that make great returns. 4) The market/world is always changing so the 'best' probabilistic model is always changing. As long as the professionals are moving faster than the non-professionals, they can still extract money. Could you define what you mean by the real economy? Isn't the real economy whatever it is that solves other people's problems that they will pay you for? The fact that "the sector is shrinking" doesn't mean that its not going to grow still larger long term. I would say that we're just on the back side of a bubble. There are many many many people out there who call themselves quants that shouldn't. You're waxing philosophic about a hyper efficient future but I don't think it matters because that future won't be here for a very long time. See 1), 4) and the second to last setence of your allegory (Information only makes a difference if the number of people who have it is small.) for why professionals/someone will always be able to make good returns.
- BenoitEssiambre 16y ago
  You make some valid points but don't forget that even the non professionals making mistakes will get less losses and a return closer to a long term index when better quant system are betting agains each other and keeping prices close to their optimum levels. It is not certain at all that the worst professional models will make money just because there are non professionals that are even worst. If the better models are aggressive enough, they should be able to take most of what there is to take from the non professionals and also profit from betting against the lesser professional models (to a lesser extent). I still maintain that as the models get better and better while they bet against each other, the margin for profit is reduced and the sector as a whole should shrink and that's a victory for capitalism.
  - secretasiandan 16y ago
    "don't forget that even the non professionals making mistakes will get less losses and a return closer to a long term index when better quant system are betting agains each other and keeping prices close to their optimum levels." Do you have an argument/explanation for this? Also, why are the quant systems necessarily betting against each other? "It is not certain at all that the worst professional models will make money just because there are non professionals that are even worst." I didn't mean to imply that its a certainty, only that its a possibility. I mean our whole argument is about some possible utopian future, right? "I still maintain that as the models get better and better while they bet against each other, the margin for profit is reduced and the sector as a whole should shrink and that's a victory for capitalism." Aren't you just saying capitalism works? Can't I say the same thing about all those darn internet startups extracting value from me because they're providing me information? Would you use the same argument to conclude that the space of internet startups will shrink?
jbooth 16y ago
Actually, almost everything about Wall Street demolishes the efficient market hypothesis. Numerous studies have said that an index fund will almost always beat a managed fund after you take out the management fees. So who's paying all of these people's BMW leases? Their sales skills. If you can give an unsophisticated investor a fuzzy feeling that their money's safer with you than an index fund, you get your management fee, whether or not you outperform the market after it's taken out. That's the opposite of the efficient market hypothesis, is it not?
- yummyfajitas 16y ago
  The efficient market hypothesis states that a trader can't beat the market except by chance. Everything you just said is evidence in favor of efficient markets. http://en.wikipedia.org/wiki/Efficient-market_hypothesis http://en.wikipedia.org/wiki/Efficient-market_hypothesis
  - jbooth 16y ago
    I thought he was referring to the old perfect information canard in misreadings of Adam Smith. Thanks. EDIT: I actually don't believe in that hypothesis, either :) I think stock prices are more reflective of crowd dynamics and emergent properties of the various algos (what % are computer driven, now?) than it is by actual prospects of the business in question. Tech stocks are a great example, I see them get pummeled or inflated for terrible reasons on the few occasions I look at market prices. So I think it's eminently beatable, both in an algorithmic and in a Buffet-fundamentals sense, I just think that anyone who beats it will naturally raise their management fees by just as much.

joshu 16y ago

Yes. There's been a huge hedge fund boom for years, and it'd been buoyed by the rising market. (a proper hedge fund ought to be uncorrelated to the market, else it would be cheaper to go long the market more directly. But I digress) This is the natural evolution of an underperforming asset class.

SkyMarshal 16y ago
Yes, 'hedge' fund is (a probably intentionally) amusing misnomer.

secretasiandan 16y ago

1) There will always be non-professionals/non-quantitative people making trades that create potential profit for those who wish to arb them. 2) You can still make "good" returns even when you have the worst of the models because of 1). 3) It takes more than N>>2 firms to shrink the profit in a particular model to 0. For evidence, see the large number of high frequency funds that make great returns. 4) The market/world is always changing so the 'best' probabilistic model is always changing. As long as the professionals are moving faster than the non-professionals, they can still extract money. Could you define what you mean by the real economy? Isn't the real economy whatever it is that solves other people's problems that they will pay you for? The fact that "the sector is shrinking" doesn't mean that its not going to grow still larger long term. I would say that we're just on the back side of a bubble. There are many many many people out there who call themselves quants that shouldn't. You're waxing philosophic about a hyper efficient future but I don't think it matters because that future won't be here for a very long time. See 1), 4) and the second to last setence of your allegory (Information only makes a difference if the number of people who have it is small.) for why professionals/someone will always be able to make good returns.

BenoitEssiambre 16y ago
You make some valid points but don't forget that even the non professionals making mistakes will get less losses and a return closer to a long term index when better quant system are betting agains each other and keeping prices close to their optimum levels. It is not certain at all that the worst professional models will make money just because there are non professionals that are even worst. If the better models are aggressive enough, they should be able to take most of what there is to take from the non professionals and also profit from betting against the lesser professional models (to a lesser extent). I still maintain that as the models get better and better while they bet against each other, the margin for profit is reduced and the sector as a whole should shrink and that's a victory for capitalism.
- secretasiandan 16y ago
  "don't forget that even the non professionals making mistakes will get less losses and a return closer to a long term index when better quant system are betting agains each other and keeping prices close to their optimum levels." Do you have an argument/explanation for this? Also, why are the quant systems necessarily betting against each other? "It is not certain at all that the worst professional models will make money just because there are non professionals that are even worst." I didn't mean to imply that its a certainty, only that its a possibility. I mean our whole argument is about some possible utopian future, right? "I still maintain that as the models get better and better while they bet against each other, the margin for profit is reduced and the sector as a whole should shrink and that's a victory for capitalism." Aren't you just saying capitalism works? Can't I say the same thing about all those darn internet startups extracting value from me because they're providing me information? Would you use the same argument to conclude that the space of internet startups will shrink?

jbooth 16y ago

Actually, almost everything about Wall Street demolishes the efficient market hypothesis. Numerous studies have said that an index fund will almost always beat a managed fund after you take out the management fees. So who's paying all of these people's BMW leases? Their sales skills. If you can give an unsophisticated investor a fuzzy feeling that their money's safer with you than an index fund, you get your management fee, whether or not you outperform the market after it's taken out. That's the opposite of the efficient market hypothesis, is it not?

yummyfajitas 16y ago
The efficient market hypothesis states that a trader can't beat the market except by chance. Everything you just said is evidence in favor of efficient markets. http://en.wikipedia.org/wiki/Efficient-market_hypothesis http://en.wikipedia.org/wiki/Efficient-market_hypothesis
- jbooth 16y ago
  I thought he was referring to the old perfect information canard in misreadings of Adam Smith. Thanks. EDIT: I actually don't believe in that hypothesis, either :) I think stock prices are more reflective of crowd dynamics and emergent properties of the various algos (what % are computer driven, now?) than it is by actual prospects of the business in question. Tech stocks are a great example, I see them get pummeled or inflated for terrible reasons on the few occasions I look at market prices. So I think it's eminently beatable, both in an algorithmic and in a Buffet-fundamentals sense, I just think that anyone who beats it will naturally raise their management fees by just as much.