Investment Banks/Quants/Gambling

[eastbay]

I browsed the book "My Life As a Quant" by some guy who went from physicist to quant analyst for Goldman Sachs. This was sort of interesting to me as my background is similar.

I realized how ignorant I am of investment banks and what they do. One thing they seem to do is employ traders who trade in, say, bond markets. I guess the quants help advise the traders in finding good trading opportunities.

The role of the model as described by Derman in the book is to "turn opinions into prices" and after reading about how some of the models work, I realized there is almost a perfect analogy with poker playing. In poker, a "model" (I guess we think of this as an analysis) turns opinions about your opponent's holdings, actions and reactions to your moves into an expected value of your play. This is no different from turning opinions about interest rate movements into expected values of trades in a bond market.

So really when you come down to it, are these guys at investment banks just glorified gamblers? Do they recognize the parallels between what they do and playing poker or other gambling games?

My second question is: if these guys are really good at this, why don't they quit, take their accumulated bonus money (which I hear can be sizable), and make their own fortune doing the same? (I guess there is a risk/return equation here to be considered.)

Are there individual investors applying this kind of analysis in the "fixed income" (don't know why it's called that) securities markets? Is that not a practical way to make money in the markets because the competition is too good?

It's obviously possible in the "poker market" because the competition doesn't even know how to think about these things well, or really care to, oftentimes. I guess the story is very different in the big investment markets, but it's not entirely clear why, by comparison, the "poker market" is so inefficient compared to, say, the bond market. Or is it?

Anyway, long, rambling and semi-coherent, but would enjoy feedback from anyone who knows about these things.

eastbay

[crazy canuck]

Most quants do not develop trading strategies, instead they are involved in risk management. In fact most of my friends who did master's in mathematical finance have no clue how to develop a trading strategy (but there isn't as much trading
here in Canada as in the US so it might be different there). So many quants can price exotic options using numerous complicated models but they wouldn't be able to beat the market. It's not that suprising tho, because the market is WAY more efficient than poker. Also, many quants have a very different view of the market from traders/gamblers (at least the ones with math background). Stock prices are assumed to be random, usually geometric brownian motion (or levy distribution or modified GBM with jumps etc), which is a very limited view, but it works well for risk management.

[Paluka]

[ QUOTE ]
Most quants do not develop trading strategies, instead they are involved in risk management. In fact most of my friends who did master's in mathematical finance have no clue how to develop a trading strategy (but there isn't as much trading
here in Canada as in the US so it might be different there). So many quants can price exotic options using numerous complicated models but they wouldn't be able to beat the market. It's not that suprising tho, because the market is WAY more efficient than poker. Also, many quants have a very different view of the market from traders/gamblers (at least the ones with math background). Stock prices are assumed to be random, usually geometric brownian motion (or levy distribution or modified GBM with jumps etc), which is a very limited view, but it works well for risk management.

[/ QUOTE ]

I think there are plenty of successful professional traders who view stock prices as essentially random.

[crazy canuck]

I think there are plenty of successful professional traders who view stock prices as essentially random.


You mean volatility traders?

[Paluka]

[ QUOTE ]

I think there are plenty of successful professional traders who view stock prices as essentially random.


You mean volatility traders?

[/ QUOTE ]

that is one kind, i'm sure there are others.