In a two part series, Emanuel Derman (author of My Life as a Quant, which I highly recommend) takes on financial engineering. He comes across as somewhat rambling, but conversational and honest. You can’t help but think he’s playing the Devil’s Advocate. Perhaps if I read Derman’s thoughts before I entered the Quantitative and Computational Finance program at Georgia Tech…

What is financial engineering?

Financial Engineering is a multidisciplinary field. It involves financial knowledge, business knowledge, mathematics, statistics, and very importantly, computation, because there’s little you can achieve without computation. There are very few analytic solutions that apply to the markets and products you actually deal with, so you must approximate all the time, and decide what complexities to ignore.

Have to agree that there are few geniuses in the field. Practice with coding and experience is the key:

Because of this you need experience to be genuinely useful, and so there are very few young geniuses in the field, unlike mathematics or chess. Experience and some wisdom is often necessary, because you’re dealing with people and their quirks, and a large part of it is a social science. Hard science assumes there is a stable world underlying the observed phenomenon; in social sciences that stability is much less obvious, perhaps even non-existent, because you’re playing with people and they keep changing the rules.

The disillusionment that can come with a technical job, I think, doesn’t have to apply to financial engineering only:

If you go to work in a big investment bank, you’ll soon discover that traders and salespeople order you about and often make more money but have less technical skills than you. That’s less true today, when more trading is technology and algorithm based, and when products are more complex, and when the buy side offers many different opportunities, but it’s still often the case.

Many practitioners or programmers gets weary after a while, and want to become “one of them.” But they may not have the skill or more importantly the personality to do that. There are more opportunities these days, especially at hedge funds, but nevertheless I’ve seen many people get disillusioned by having to continue in their mainly technical role. Can you change to be what you want? Can you live with being who you are?

Derman comes across as a more grandiose Devil’s Advocate in Part 2, as evidenced here:

Many people think you’re mis-employing your talents when you go to work in finance. (Nevertheless, when people ask me if I couldn’t be using my skills more usefully, I ask them the same.) Yes, you are adding to knowledge, but what is it used for? Often, simply to make money. Yes, that making of money may make markets more efficient, but is that sufficient social justification? I sometimes think that at least in finance, to paraphrase Johnson, invoking efficiency is the last refuge of scoundrels/self-interested people. But everyone is self-interested.

Do you believe everyone is self-interested? What about those that become doctors? That volunteer in the Peace Corps?

Derman concludes that he’s not a saint (we’re not curing cancer, after all):

I like to think that part of our job on earth is to be perceptive and accurate about as much as possible, including ourselves, about the way the world really works. If you do that, even for small things, it can add up to something bigger. It’s the one standard that transcends individual fields of study. That’s part of my rationale. There are others parts too. But mostly, it’s interesting work and sometimes useful and I’m not a saint.

If you’re thinking about applying to financial engineering programs (Masters in Financial Engineering, or MFE), Derman’s two posts are worth your time. Excellent food for thought.