The Physics of Wall Street: A Brief History of Predicting the Unpredictable by J

Description: The Physics of Wall Street by James Owen Weatherall A young scholar tells the story of the physicists and mathematicians who created the models that have become the basis of modern finance and argues that these models are the solution to--not the source of--our current economic woes. FORMAT Paperback LANGUAGE English CONDITION Brand New Publisher Description "Weatherall probes an epochal shift in financial strategizing with lucidity, explaining how it occurred and what it means for modern finance."--Peter Galison, author of Einsteins Clocks, Poincares Maps After the economic meltdown of 2008, many pundits placed the blame on "complex financial instruments" and the physicists and mathematicians who dreamed them up. But how is it that physicists came to drive Wall Street? And were their ideas really the cause of the collapse? In The Physics of Wall Street, the physicist James Weatherall answers both of these questions. He tells the story of how physicists first moved to finance, bringing science to bear on some of the thorniest problems in economics, from bubbles to options pricing. The problem isnt simply that economic models have limitations and can break down under certain conditions, but that at the time of the meltdown those models were in the hands of people who either didnt understand their purpose or didnt care. It was a catastrophic misuse of science. However, Weatherall argues that the solution is not to give up on the models but to make them better. Both persuasive and accessible, The Physics of Wall Street is riveting history that will change how we think about our economic future. Back Cover "Weatherall probes an epochal shift in financial strategizing with lucidity, explaining how it occurred and what it means for modern finance."--Peter Galison, author of Einsteins Clocks, Poincares Maps After the economic meltdown of 2008, many pundits placed the blame on "complex financial instruments" and the physicists and mathematicians who dreamed them up. But how is it that physicists came to drive Wall Street? And were their ideas really the cause of the collapse? In The Physics of Wall Street , the physicist James Weatherall answers both of these questions. He tells the story of how physicists first moved to finance, bringing science to bear on some of the thorniest problems in economics, from bubbles to options pricing. The problem isnt simply that economic models have limitations and can break down under certain conditions, but that at the time of the meltdown those models were in the hands of people who either didnt understand their purpose or didnt care. It was a catastrophic misuse of science. However, Weatherall argues that the solution is not to give up on the models but to make them better. Both persuasive and accessible, The Physics of Wall Street is riveting history that will change how we think about our economic future. "An excellent new book."-- Financial Times [AU PHOTO] JAMES OWEN WEATHERALL is a physicist, philosopher, and mathematician. He holds graduate degrees from Harvard, the Stevens Institute of Technology, and the University of California, Irvine, where he is presently an assistant professor of logic and philosophy of science. He has written for Slate and Scientific American. He lives in Irvine, California. Author Biography JAMES OWEN WEATHERALL is a physicist, philosopher, and mathematician. He holds graduate degrees from Harvard, the Stevens Institute of Technology, and the University of California, Irvine, where he is presently an assistant professor of logic and the philosophy of science. He has written for Slate and Scientific American. Review "Fascinating history...Happily, the author has a gift for making complex concepts clear to lay readers."--Booklist "A lively account of physicists in finance...An enjoyable debut appropriate for both specialists and general readers."--Kirkus "Anyone interested in how markets work will appreciate this serious hypothesis."--Publishers Weekly "A compelling case for models in economics and an important book for anyone who embraces the scientific method for improving the lot of mankind."--Michael Brown, former CFO of Microsoft Corporation, past chairman of NASDAQ "Weatherall probes an epochal shift in financial strategizing with lucidity, explaining how it occurred and what it means for modern finance."--Peter Galison, author of Einsteins Clocks, Poincares Maps "Weatheralls rollicking tale of science and profit has relevance to us all. He goes beyond the Frankensteins monster cliché to argue that mathematical models are an essential foundation of a saner future."--William Poundstone, author of Fortunes Formula "This book will lead you to reexamine what you thought you knew about the financial markets, and why it is so important for the economists to actually listen to what the physicists have been trying to tell them."--Bill Maurer, director of the Institute for Money, Technology and Financial Inclusion, University of California, Irvine "Weatherall has a rare talent for making the complex comprehensible, and he puts it to excellent use explaining the role of physics and mathematics in financial markets. This is a book anyone concerned with the unforeseen consequences of financial innovations will want to read."--Lee Smolin, author of The Trouble with Physics "Beautifully written, with clarity, understanding, and a broad view that is rare in these domains. Even those of us who are unconvinced physics has played an important role in finance will be carried along and learn from this engaging book." --Stephen M. Stigler, Ernest DeWitt Burton Distinguished Service Professor of Statistics, University of Chicago "James Weatherall channels the sheer intellectual excitement of unlocking the secrets of nature, whether they relate to fundamental particles or financial markets."--Hans Halvorson, professor of philosophy, Princeton University "With The Physics of Wall Street, James Weatherall has announced his arrival as one of our leading young science writers. This smart, fast-paced history of ideas--which is packed with vivid portraits of brainiacs famous and obscure and offers a provocative analysis of our current economic woes--should appeal to a broad range of readers, from hard-core science junkies to business folks trying to make sense of modern finance."--John Horgan, Director, Center for Science Writings, Stevens Institute of Technology -- Review Quote "Fascinating history...Happily, the author has a gift for making complex concepts clear to lay readers." e" Booklist "A lively account of physicists in finance...An enjoyable debut appropriate for both specialists and general readers." e"Kirkus "Anyone interested in how markets work will appreciate this serious hypothesis." e" Publishers Weekly "A compelling case for models in economics and an important book for anyone who embraces the scientific method for improving the lot of mankind."ee e"Michael Brown, former CFO of Microsoft Corporation, past chairman of NASDAQ"Weatherall probes an epochal shift in financial strategizing with lucidity, explaining how it occurred and what it means for modern finance." e"Peter Galison, author of Einsteine(tm)s Clocks, Poincaree(tm)s Maps "Weatheralle(tm)s rollicking tale of science and profit has relevance to us all.ee He goes beyond the e~Frankensteine(tm)s monstere(tm) clich to argue that mathematical models are an essential foundation of a saner future." e"William Poundstone, author of Fortunes Formula "This book will lead you to reexamine what you thought you knew about the financial markets, and why it is so important for the economists to actually listen to what the physicists have been trying to tell them." e"Bill Maurer, director of the Institute for Money, Technology and Financial Inclusion, University of California, Irvine "Weatherall has a rare talent for making the complex comprehensible, and he puts it to excellent use explaining the role of physics and mathematics in financial markets. This is a book anyone concerned with the unforeseen consequences of financial innovations will want to read." e"Lee Smolin, author of The Trouble with Physics "Beautifully written, with clarity, understanding, and a broad view that is rare in these domains.ee Even those of us who are unconvinced physics has played an important role in finance will be carried along and learn from this engaging book." e"Stephen M. Stigler, Ernest DeWitt Burton Distinguished Service Professor of Statistics, University of Chicago"James Weatherall channels the sheer intellectual excitement of unlocking the secrets of nature, whether they relate to fundamental particles or financial markets." e"Hans Halvorson, professor of philosophy, Princeton University"With The Physics of Wall Street , James Weatherall has announced his arrival as one of our leading young science writers. This smart, fast-paced history of ideas--which is packed with vivid portraits of brainiacs famous and obscure and offers a provocative analysis of our current economic woes--should appeal to a broad range of readers, from hard-core science junkies to business folks trying to make sense of modern finance." e"John Horgan, Director, Center for Science Writings, Stevens Institute of Technology Excerpt from Book Introduction: Of Quants and Other Demons WARREN BUFFETT ISNT the best money manager in the world. Neither is George Soros or Bill Gross. The worlds best money manager is a man youve probably never heard of - unless youre a physicist, in which case youd know his name immediately. Jim Simons is co-inventor of a brilliant piece of mathematics called the Chern-Simons 3-form, one of the most important parts of string theory. Its abstract, even abstruse, stuff - some say too abstract and speculative - but it has turned Simons into a living legend. Hes the kind of scientist whose name is uttered in hushed tones in the physics departments of Harvard and Princeton. Simons cuts a professorial figure, with thin white hair and a scraggly beard. In his rare public appearances, he usually wears a rumpled shirt and sports jacket - a far cry from the crisp suits and ties worn by most elite traders. He rarely wears socks. His contributions to physics and mathematics are as theoretical as could be, with a focus on classifying the features of complex geometrical shapes. Its hard to even call him a numbers guy - once you reach his level of abstraction, numbers, or anything else that resembles traditional mathematics, are a distant memory. He is not someone you would expect to find wading into the turbulent waters of hedge fund management. And yet, there he is, the founder of the extraordinarily successful firm Renaissance Technologies. Simons created Renaissances signature fund in 1988, with another mathematician named James Ax. They called it Medallion, after the prestigious mathematics prizes that Ax and Simons had won in the sixties and seventies. Over the next decade, the fund earned an unparalleled 2,478.6% return, blowing every other hedge fund in the world out of the water. To give a sense of how extraordinary this is, George Soross Quantum Fund, the next most successful fund during this time, earned a mere 1,710.1% over the same period. Medallions success didnt let up in the next decade, either - over the lifetime of the fund, Medallions returns have averaged almost 40% a year, after fees that are twice as high as the industry average. (Compare this to Berkshire Hathaway, which averaged a 20% return from when Buffett turned it into an investment firm in 1967 until 2010.) Today Simons is one of the wealthiest men in the world. According to the 2011 Forbes ranking, his net worth is $10.6 billion, a figure that puts Simonss checking account in the same range as that of some high-powered investment firms. Renaissance employs about two hundred people, mostly at the companys fortresslike headquarters in the Long Island town of East Setauket. A third of them have PhDs - not in finance, but rather, like Simons, in fields like physics, mathematics, and statistics. According to MIT mathematician Isadore Singer, Renaissance is the best physics and mathematics department in the world - which, say Simons and others, is why the firm has excelled. Indeed, Renaissance avoids hiring anyone with even the slightest whiff of Wall Street bona fides. PhDs in finance need not apply; nor should traders who got their start at traditional investment banks or even other hedge funds. The secret to Simonss success has been steering clear of the financial experts. And rightly so. According to the financial experts, people like Simons shouldnt exist. Theoretically speaking, hes done the impossible. Hes predicted the unpredictable, and made a fortune doing it. Hedge funds are supposed to work by creating counterbalanced portfolios. The simplest version of the idea is to buy one asset while simultaneously selling another asset as a kind of insurance policy. Often, one of these assets is what is known as a derivative. Derivatives are contracts based on some other kind of security, such as stocks, bonds, or commodities. For instance, one kind of derivative is called a futures contract. If you buy a futures contract on, say, grain, you are agreeing to buy the grain at some fixed future time, for a price that you settle on now. The value of a grain future depends on the value of grain - if the price of grain goes up, then the value of your grain futures should go up too, since the price of buying grain and holding it for a while should also go up. If grain prices drop, however, you may be stuck with a contract that commits you to paying more than the market price of grain when the futures contract expires. In many cases (though not all), there is no actual grain exchanged when the contract expires; instead, you simply exchange cash corresponding to the discrepancy between the price you agreed to pay and the current market price. Derivatives have gotten a lot of attention recently, most of it negative. But they arent new. They have been around for at least four thousand years, as testified by clay tablets found in ancient Mesopotamia (modern-day Iraq) that recorded early futures contracts. The purpose of such contracts is simple: they reduce uncertainty. Suppose that Anum-pisha and Namran-sharur, two sons of Siniddianam, are Sumerian grain farmers. They are trying to decide whether they should plant their fields with barley, or perhaps grow wheat instead. Meanwhile, the priestess Iltani knows that she will require barley next autumn, but she also knows that barley prices can fluctuate unpredictably. On a hot tip from a local merchant, Anum-pisha and Namran-sharur approach Iltani and suggest that she buy a futures contract on their barley; they agree to sell Iltani a fixed amount of barley for a prenegotiated price, after the harvest. That way, Anum-pisha and Namran-sharur can confidently plant barley, since they have already found a buyer. Iltani, meanwhile, knows that she will be able to acquire sufficient amounts of barley at a fixed price. In this case, the derivative reduces to the sellers risk of producing the goods in the first place, and at the same time, it shields the purchaser from unexpected variations in price. Of course, theres always a risk that the sons of Siniddianam wont be able to deliver - what if there is a drought or a blight? - in which case they would likely have to buy the grain from someone else and sell it to Iltani at the predetermined rate. Hedge funds use derivatives in much the same way as ancient Mesopotamians. Buying stock and selling stock market futures is like planting barley and selling barley futures. The futures provide a kind of insurance against the stock losing value. The hedge funds that came of age in the 2000s, however, did the sons of Siniddianam one better. These funds were run by traders, called quants, who represented a new kind of Wall Street elite. Many had PhDs in finance, with graduate training in state-of-the-art academic theories - never before a prerequisite for work on the Street. Others were outsiders, with backgrounds in fields like mathematics or physics. They came armed with formulas designed to tell them exactly how derivatives prices should be related to the securities on which the derivatives were based. They had some of the fastest, most sophisticated computer systems in the world programmed to solve these equations and to calculate how much risk the funds faced, so that they could keep their portfolios in perfect balance. The funds strategies were calibrated so that no matter what happened, they would eke out a small profit - with virtually no chance of significant loss. Or at least, that was how they were supposed to work. But when markets opened on Monday, August 6, 2007, all hell broke loose. The hedge fund portfolios that were designed to make money, no matter what, tanked. The positions that were supposed to go up all went down. Bizarrely, the positions that were supposed to go up if everything else went down also went down. Essentially all of the major quant funds were hit, hard. Every strategy they used was suddenly vulnerable, whether in stocks, bonds, currency, or commodities. Millions of dollars started flying out the door. As the week progressed, the strange crisis worsened. Despite their training and expertise, none of the traders at the quant funds had any idea what was going on. By Wednesday matters were desperate. One large fund at Morgan Stanley, called Process Driven Trading, lost $300 million that day alone. Another fund, Applied Quantitative Research Capital Management, lost $500 million. An enormous, highly secretive Goldman Sachs fund called Global Alpha was down $1.5 billion on the month so far. The Dow Jones, meanwhile, went up 150 points, since the stocks that the quant funds had bet against all rallied. Something had gone terribly, terribly wrong. The market shakeup continued through the end of the week. It finally ended over the weekend, when Goldman Sachs stepped in with $3 billion in new capital to stabilize its funds. This helped stop the bleeding long enough for the immediate panic to subside, at least for the rest of August. Soon, though, word of the losses spread to business journalists. A few wrote articles speculating about the cause of what came to be called the quant crisis. Even as Goldmans triage saved the day, however, explanations were difficult to come by. The fund managers went about their business, nervously hoping that the week from hell had been some strange fluke, a squall that had passed. Many recalled a quote from a much earlier physicist. After losing his hat in Description for Bookstore HMH hardcover, 2013 Previous ISBN: 978-0-547-31727-4 Details ISBN0544112431 Author James Owen Weatherall Pages 304 Language English ISBN-10 0544112431 ISBN-13 9780544112438 Format Paperback Short Title PHYSICS OF WALL STREET Media Book Subtitle A Brief History of Predicting the Unpredictable Country of Publication United States AU Release Date 2014-02-04 NZ Release Date 2014-02-04 UK Release Date 2014-02-04 Imprint Harper Business Publisher Harper Business DEWEY 332.6320973 Illustrations Illustrations, unspecified Audience General Year 2014 Publication Date 2014-02-04 US Release Date 2014-02-04 Imprint US Harper Business Publisher US HarperCollins We've got this At The Nile, if you're looking for it, we've got it. 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