Business Blog: Hoover’s Business Insight Zone

“Quant” fund managers, using fancy mathematics derived by Nobel-crowned economists, have made big waves in recent years. Heck, a very successful quant-minded mogul just picked up his second World Series ring.*

Nassim Nicholas Taleb, author of the scintillating book, The Black Swan: The Impact of the Highly Improbable, lays into the quants and their modern portfolio theory (MPT) in this blistering Financial Times column:

The pseudo-science hurting markets

…MPT produces measures such as “sigmas”, “betas”, “Sharpe ratios”, “correlation”, “value at risk”, “optimal portfolios” and “capital asset pricing model” that are incompatible with the possibility of those consequential rare events I call “black swans” (owing to their rarity, as most swans are white). So my problem is that the prize is not just an insult to science; it has been putting the financial system at risk of blow-ups.

I was a trader and risk manager for almost 20 years (before experiencing battle fatigue). There is no way my and my colleagues’ accumulated knowledge of market risks can be passed on to the next generation. Business schools block the transmission of our practical know-how and empirical tricks and the knowledge dies with us. We learn from crisis to crisis that MPT has the empirical and scientific validity of astrology (without the aesthetics), yet the lessons are ignored in what is taught to 150,000 business school students worldwide.

…The knowledge and risk awareness we are accumulating from the current subprime crisis and its aftermath will most certainly not make it to business schools. The previous dozen crises and experiences did not do so. It will be dying with us, unless we discredit that absurd Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel commonly called the “Nobel Prize”.

Tom Peters pointed to this piece and used it to reiterate his disgust with quants and their methods. Mind you that Peters was trained in engineering at Cornell and has a Stanford Ph.D. in business, so he’s hardly anti-math. He just agrees with Taleb that an overemphasis on quantitative methods stinks.

I was around Bill Sharpe, the Nobel-holding, more or less father of contemporary portfolio theory, engine of our current woes, when he did the work that won the prize—I was mostly ignorant of what was up, but appalled by the apparent arrogance of Sharpe and his devotees. It was clear—to them—that risk would be tamed, once and for all.

Apparently risks are just a little more resistant to quant methods that has been thought. And apparently I should start qualifying my statements when I talk about “Nobel-crowned” economists.

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* I hope John Henry’s Wikipedia biography is accurate, but geez, doesn’t it read like it’s made up? Testicular cancer at 15? “majoring in philosophy but failed to obtain his degree due in part to traveling with rock and roll bands called Elysian Fields and Hillary.” Seriously? Wow — and here I thought he was an Ivy League-style stiff.