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Jacob Wolinsky
Jacob Wolinsky
Articles  | Author's Website |

The Financial Crisis You Never Heard About. Book Review: The Quants by Scott Patterson

This is my 12th book review on books related to the current financial crisis. To see my previous book reviews check my previous articles. My most recent book is The Quants: How a New Breed of Math Whizzes Conquered Wall Street and Nearly Destroyed It by Scott Patterson. Scott Patterson is a staff reporter at the Wall Street Journal. The book was released on Feb 2, 2010.

The book starts off with details of the genius gambler and trader Ed Thorp. Ed Thorp is the man who discovered card counting and was able to use it to beat the house in Black Jack. Ed Thorp would later use make millions of dollars in the stock market using mathematical formulas. Scott Patterson described Ed Thorp as “the God Father” of the Quant movement. Scott Patterson describes in detail Thorp’s attempts to use math to make money. Thorp would use his math skills to find arbitrage situations where he could make a quick profit with little risk. He used mathematical models to value convertible bonds and made a killing pioneering convertible bond arbitrage. Thorp closed his fund when many copy cats started using his strategies and he thought the field was getting too crowded.

The book describes several math whizzes that went on to develop quantitative strategies to quickly exploit inefficiencies in the market. The book describes the Quants as nerds who could not get dates in High School, and spent their time conducting bizarre science and math experiments. They typically got their PHDs in Mathematics from schools like MIT or the University of Chicago. They were students of Ed Thorp, who even helped one of them set up their quant fund.

They also were strong believers in Eugene Fama and the efficient market theory. Eugene Fama believes that the market is efficient and that it always reflecting all known data. When the market is not priced correctly knowledgeable investors will quickly come in and either buy or sell to the point where the market reaches equilibrium. This is where the Quants come in. They would use their complex formulas to find these small inefficiencies in the market and using rapid trading techniques profit off these inefficiencies.

Some of the Quants described in detail in the book were Guru Ken Griffin of Citadel Investment Group, Peter Muller of Morgan Stanley’s hedge fund PDT, Cliff Asness founder of AQR Capital Management, Jim Simons of Renaissance Technologies, and Boaz Weinstein who ran hedge funds at both Morgan Stanley and Deutsche Bank.

The Quants like their mentor Ed Thorp, did not only use their models to beat the market. The Quants regularly played games of Poker with each other. Many of the Quants mentioned in the book were expert poker players, winning various professional poker tournaments.

What is particularly interesting about the book is Scott Patterson’s description of the financial crisis that took place in August 2007. You probably never heard about this crisis because media barely reported it. Yet in August 2007 several Quant funds with a combined several hundred billion dollars in assets, were on the verge of collapse.

There has been very little has been of hedge funds and the systematic risk their collapse could cause. Every book I have read on the crisis details September 2008 when Lehman Brothers, AIG and the many other financial institutions were teetering on the verge of collapse.

Scott Patterson details the near collapse of the financial system a year before the one in September 2008. The massive losses for the Quant funds started in August 2007 before the damage was really being felt in the rest of the financial sector. Suddenly, the models the Quants were using started not working. What happened was what Nissim Taleb described as a “a Black Swan event”. This refers to unexpected events that have a large and sudden impact.

When the Black Swan came even where the Quants hedged their bets they would lose. For example a fund that was short General Motor’s stock and long its bonds, lost lots of money when the stock rose but the bonds fell. According to the models the Quants developed this was impossible. According to Patterson it was as if someone flipping a coin “got a dozen straight flips where the coin landed on its edge.”

The Quant Funds were losing hundreds of millions, sometimes billions of dollars a day for several days in a row. What had happened was an event that to the Quants was impossible. Mathew Rothman who ran a Quant fund at Lehman Brothers stated” events that models predicted would happen once in 10,000 years happened every day for three days.” There was a fear of an LTCM type collapse on a far larger scale considering these funds had hundreds of billions of dollars in assets.

The one thing the book is lacking is some description of the mathematical formulas the Quants used (I doubt anyway many readers including myself would understand them anyway). However, this is not the fault of the author Scott Patterson. The Quants were very secretive in the formulas they developed. Scott Patterson stated that he asked some current and former employees at Quant Hedge fund Renaissance about the formulas and no one would speak. Robert Muller who ran a hedge fund named PDT owned by Morgan Stanley, would not give details about the fund to Morgan’s CEO John Mack for fear of the secrets being released.

I really enjoyed the book. While reading about Ed Thorp and the other Quants I contemplated becoming a Quant (not that I am a genius in math or a geek) and becoming a professional poker player. This lasted for a few minutes until I got back to my senses.

This book would be enjoyable for someone who has background in finance since this book covers an area most books on the financial crisis do not cover whatsoever. This book also is good for a reader with little background in finance too, since the author does not use complex financial jargon.

To purchase the book on Amazon.com click on the following link The Quants: How a New Breed of Math Whizzes Conquered Wall Street and Nearly Destroyed It

Disclosure: New FTC guidelines require me to disclose I have a material connection because I received a free copy of the book to review.

Pimm Fox interviews Scott Patterson about the book

About the author:

Jacob Wolinsky
My investment ideas have been inspired by many of value investors including Benjamin Graham, Charles Royce, John Neff, Joel Greenblatt, Peter Lynch, Seth Klarman,Martin Whitman and Bruce Greenwald. .I live with my wife and daughter in Monsey, NY. I can be contacted jacobwolinsky(AT)gmail.com and my blog is www.valuewalk.com

Visit Jacob Wolinsky's Website

Rating: 3.0/5 (15 votes)


Yswolinsky - 7 years ago    Report SPAM
Anyone else read the book?
Buffetteer17 premium member - 7 years ago

I just ordered a copy. I intend to play around with programmed trading when I get some free time in retirement. While I do not have a PhD in math, I do have a PhD in computer science, and my dissertation was basically mathemetical. I'm also trying to learn poker, and currently I have a slightly positive return on PokerStars in the low stakes 10-player speed tournaments.
Yswolinsky - 7 years ago    Report SPAM
do you know if its legal to play poker for real money online now? I have not heard a clear answer

Yswolinsky - 7 years ago    Report SPAM
Buffetter if you like to play around with programmed trading i think youll love the book it really made me want to become a quant despite the fact that i am not a math geek

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