What happens when you create a quadrillion dollars out of thin air, and then blow it up?
Paul Wilmott, a quantitative finance expert, says you have a structural problem. He should know; he is the author of various academic and practitioner texts on quantitative finance, risk management of derivatives, and most recently, wrote The Money Formula: Dodgy Finance, Pseudo Science, and How Mathematicians Took Over the Markets.
Wilmott is an interesting character, not quite an academic, yet not a pure practitioner of the quantitative arts either. He says he never had a boss, and genuinely believes that one day people will pay to hear him play the ukulele live on stage. Note I took the other side of the trade and bet against it.
But what Wilmott really wants you to know are his thoughts about the quantitative models he and others have created. The positive side of the ledger is that they are the “engine room of the global economy;” The negative? They were “the cause of its most recent meltdown.”
Wilmott says that quantitative investment models, as currently deployed are a “pseudo-science.” The quant community as a whole have “misled generations of economists and investors” — and despite all of the recent turmoil, no one appears to have learned much from their experiences.
Financial models seem to make traders and managers over-confident, which leads to bad outcomes. The credit crisis was one of those bad outcomes, and to hear Wilmott describe it, not much has changed: incentives remain misaligned, no one went to prison last crisis, and other issues makes another quant driven crash inevitable.
Some of his favorite books are found here.
You can stream/download the full conversation, including the podcast extras, on Bloomberg, iTunes, Overcast, and Soundcloud. Our earlier podcasts can all be found on iTunes, Soundcloud, Overcast and Bloomberg.
Next week, we speak with Jim Ross, Chairman of State Street’s SSGA, best known as the father of the Spyders (SPY).