The Human Element in Quantification

I enjoyed Felix Salmon’s piece in Wired titled “Why Quants Don’t Know Everything.” The premise of the piece is that while what quants do is important, the human element cannot be ignored.

The reason the quants win is that they’re almost always right—at least at first. They find numerical patterns or invent ingenious algorithms that increase profits or solve problems in ways that no amount of subjective experience can match. But what happens after the quants win is not always the data-driven paradise that they and their boosters expected. The more a field is run by a system, the more that system creates incentives for everyone (employees, customers, competitors) to change their behavior in perverse ways—providing more of whatever the system is designed to measure and produce, whether that actually creates any value or not. It’s a problem that can’t be solved until the quants learn a little bit from the old-fashioned ways of thinking they’ve displaced.

Felix discusses the four stages in the rise of the quants: 1) pre-disruption, 2) disruption, 3) overshoot, and 4) synthesis, described below:

It’s increasingly clear that for smart organizations, living by numbers alone simply won’t work. That’s why they arrive at stage four: synthesis—the practice of marrying quantitative insights with old-fashioned subjective experience. Nate Silver himself has written thoughtfully about examples of this in his book, The Signal and the Noise. He cites baseball, which in the post-Moneyball era adopted a “fusion approach” that leans on both statistics and scouting. Silver credits it with delivering the Boston Red Sox’s first World Series title in 86 years. Or consider weather forecasting: The National Weather Service employs meteorologists who, understanding the dynamics of weather systems, can improve forecasts by as much as 25 percent compared with computers alone. A similar synthesis holds in eco­nomic forecasting: Adding human judgment to statistical methods makes results roughly 15 percent more accurate. And it’s even true in chess: While the best computers can now easily beat the best humans, they can in turn be beaten by humans aided by computers.

Very interesting throughout, and highly recommended.

Joining Wall Street to Save the World

The Washington Post profiles a 25-year-old Jason Trigg, who’s decided to join a high frequency trading firm to make the most amount of money as he can. But why? So he can give a lot of it away. He figures it’s a better bet than going into academia:

He’s figured out just how to take measure of his contribution. His outlet of choice is the Against Malaria Foundation, considered one of the world’s most effective charities. It estimates that a $2,500 donation can save one life. A quantitative analyst at Trigg’s hedge fund can earn well more than $100,000 a year. By giving away half of a high finance salary, Trigg says, he can save many more lives than he could on an academic’s salary.

In many ways, his life still resembles that of a graduate student. He lives with three roommates. He walks to work. And he doesn’t feel in any way deprived. “I wouldn’t know how to spend a large amount of money,” he says.

While some of his peers have shunned Wall Street as the land of the morally bankrupt, Trigg’s moral code steered him there. And he’s not alone. To an emerging class of young professionals in America and Britain, making gobs of money is the surest way to save the world. When you ask Trigg where he got the idea, his answer is a common refrain among this crowd: “I feel like I’d read stuff by Peter Singer.”

Interesting, to say the least.

How Wall Street Bankers Handled Sandy

This Bloomberg piece details how those on Wall Street handled Hurricane (Superstorm) Sandy. It’s slightly (perhaps very) disconcerting, as these people turned to $1,000 wine, delivered sushi, and Monopoly games:

“I had to go to the wine cellar and find a good bottle of wine and drink it before it goes bad,” Murry Stegelmann, 50, a founder of investment-management firm Kilimanjaro Advisors LLC, wrote in an e-mail after he lost power at 6 p.m. on Oct. 29 in Darien, Connecticut.

The bottle he chose, a 2005 Chateau Margaux, was given 98 points by wine critic Robert Parker and is on sale at the Westchester Wine Warehouse for $999.99.

“Outstanding,” Stegelmann said. He started the day with green tea at Starbucks, talking with neighbors about the New York Yankees’ future and moving boats to the parking lot of Darien’s Middlesex Middle School.

You have to click to read the rest. Using fax machines? No dumpling bar at JP Morgan? Wall Street had it rough.

A Brief History of Trading on Wall Street

You don’t get to read about history in the Dealbook blog, but we get a great one today about the history of trading on Wall Street. It’s pretty crazy to think that in the early days of Wall Street, stock prices were communicated by runners:

Even after the introduction of the trans-Atlantic cable in 1865 and the telephone in 1878, brokers still relied on manpower over gadgetry. Market prices were listed on slips of paper, and runners, most younger than 17, would deliver letters between brokerage houses, according to a report by Alexandru Preda at the University of Edinburgh. The new technologies were not seen as reliable. Problems ranged from typographical errors in the closing stock prices listed by newspapers to outright forgery.

In the days after the Civil War ended, traders seeking a timely edge still relied upon foot speed. The fastest man on Wall Street was William Heath, a celebrated runner with a huge drooping mustache, who was nicknamed “the American Deer.” Standing an inch taller than the Olympic sprinter Usain Bolt of Jamaica, Mr. Heath was reported by The New York Times to have been “as quick in his locomotion as in his operation.”

On the invention of the first ticker symbol, which was unreliable:

In 1867, Edward A. Calahan, a draftsman with the American Telegraph Company who previously worked as a messenger on Wall Street, unveiled the first stock ticker. The device, which earned its name from the unique sound it created, featured two wheels of type placed under a glass jar. The ticker printed off company names and stock prices on a narrow strip of paper, which was read aloud by a clerk.

Mr. Calahan’s machine was the first step in a major technological revolution of Wall Street, but it was also slow and unreliable. Twice a week, the batteries had to be filled with sulfuric acid, which was carried around in buckets. More important, the wheels of type would not always print in unison resulting in a mash of letters and numbers.

Catch up on the rest of the history lesson here.

How to Make $44 Million in 20 Minutes

Short answer: become and exit as CEO of Duke Energy, all in less than a day’s work.

Earlier this month, Bill Johnson enjoyed one of the shortest (and most lucrative, in dollars/hour) terms as CEO in U.S. history, as he was ousted from his new position at Duke Energy after only a few minutes on the job. Earlier today, Johnson explained to regulators that his brief time on the job was just as surprising to him as it was to the rest of the world.

Only a few weeks ago, Johnson has been the CEO of Progress Energy. Then that company merged with the larger Duke — becoming the nation’s largest electric utility provider — and Johnson was named CEO of the combined businesses… but only for about 20 minutes, at which point the board called for him to leave (with the help of a payout worth around $44 million).

The Wall Street Journal has more details about this crazy story. Call it a see-saw turn of events.

Bonus Drops and Wall Street

This Bloomberg piece describes some of the “crushing setbacks” of those working on Wall Street experiencing a reduction in bonus pay. It’s kind of ridiculous.

The man who spends $17,000 a year on two dogs:

Richard Scheiner, 58, a real-estate investor and hedge-fund manager, said most people on Wall Street don’t save.

“When their means are cut, they’re stuck,” said Scheiner, whose New York-based hedge fund, Lane Gate Partners LLC, was down about 15 percent last year. “Not so much an issue for me and my wife because we’ve always saved.”

Scheiner said he spends about $500 a month to park one of his two Audis in a garage and at least $7,500 a year each for memberships at the Trump National Golf Club in Westchester and a gun club in upstate New York. A labradoodle named Zelda and a rescued bichon frise, Duke, cost $17,000 a year, including food, health care, boarding and a daily dog-walker who charges $17 each per outing, he said.

Or how about a twentysomething guy who spent thousands on exotic vacations?

Hans Kullberg, 27, a trader at Wyckoff, New Jersey-based hedge fund Falcon Management Corp. who said he earns about $150,000 a year, is adjusting his sights, too.

After graduating from the Wharton School of the University of Pennsylvania in 2006, he spent a $10,000 signing bonus from Citigroup Inc. (C) on a six-week trip to South America. He worked on an emerging-markets team at the bank that traded and marketed synthetic collateralized debt obligations.

His tastes for travel got “a little bit more lavish,” he said. Kullberg, a triathlete, went to a bachelor party in Las Vegas in January after renting a four-bedroom ski cabin at Bear Mountain in California as a Christmas gift to his parents. He went to Ibiza for another bachelor party in August, spending $3,000 on a three-day trip, including a 15-minute ride from the airport that cost $100. In May he spent 10 days in India.

Is the suffering relative and real, as one professor in the article attests?

On Harvard and Wall Street

Why do so many Harvard students end up going into finance upon graduation? It’s a topic I’ve blogged about before, but Ezra Klein chimes in to the discussion and explains that the liberal education at Harvard is failing the students, and this provides a golden opportunity for Wall Street:

What Wall Street figured out is that colleges are producing a large number of very smart, completely confused graduates. Kids who have ample mental horsepower, incredible work ethics and no idea what to do next. So the finance industry takes advantage of that confusion, attracting students who never intended to work in finance but don’t have any better ideas about where to go.

It begins by mimicking the application process Harvard students have already grown comfortable with. “It’s doing a process that you’ve done a billion times before,” explains Dylan Matthews, a Harvard senior.

“Everyone who goes to Harvard went hard on the college application process. Applying to Wall Street is much closer to that than applying anywhere else is. There are a handful of firms you really care about, they all have formal application processes that they walk you through, there’s a season when it all happens, all of them come to you and interview you where you live. Harvard students are really good at formal processes like that, and they’re less good at going on Monster or Craigslist and sorting through thousands of job listings from thousands of companies whose reputations they don’t know. Wall Street and consulting (and Teach for America, too) turn applying to jobs into applying to college, more or less.”

Yet that’s only half of it. A bigger draw, explained a recent Harvard graduate who majored in social science and worked at Goldman Sachs for two years, is how Wall Street sells itself to potential applicants: As a low-risk, high-return opportunity that they can try for a few years and, whether they like it or hate it, use to acquire real skills to build careers.

In other words, Wall Street is promising to give graduates the skills their university education didn’t. It’s providing a practical graduate school that pays students handsomely to attend. Sometimes, the enrollees end up liking their job in finance, or liking the lifestyle that it affords them, so they stick around. Sometimes, they don’t. Either way, Wall Street is filling a need that our educational system should be filling.

So it seems universities have been looking at the problem backward. The issue isn’t that so many of their well-educated students want to go to Wall Street rather than make another sort of contribution. It’s that so many of their students end up feeling so poorly prepared that they go to Wall Street because they’re not sure what other contribution they can make.

Your thoughts?