How do quants contribute to society?

[John622]

Hi,
I've been in a Financial Engineering PhD program at a tier 1 US university for about a year now. The mathematics is very interesting and is a good intersection of PDE, Probability, and CS. However, whenever I see the numerical application of my work in Bloomberg, I can't help but feel that all I'm doing is some how help a fund get better at gambling on the stock market. Then when this fund gets better at gambling, the other firms have to hire better quants to improve their models. It's like a "modeling arms race". When I look back at history in the longer run, I can' explain to myself how has the advances in quantitative finance in the last 25 years made the world a better place.

Sorry if this seems rude, but it's been seriously bothering me for quite a while now. My alternative would be to pursue something in Operations Research or switch into Mechanical or Electrical Engineering. My understanding is that high level Mechanics is quite math heavy too?

John

[fedja]

[Xevarion]

I have been thinking about the same question lately. I'm just finishing my junior year of undergrad, and I'll have the opportunity to work for a good hedge fund after I graduate if I want (probably), so I have to decide if I want to do that or if I should be applying to graduate schools.


I can only think of one "social" justification for the work that hedge funds do. They make markets more efficient. The whole point of working for a hedge fund is trying to identify where the market is inefficient and profit from it; this will remove the inefficiency. (Personally, I think the fact that there's uncertainty in this process does NOT make it the same as gambling.) Essentially, hedge funds provide a service of improving market stability and providing liquidity.

But even if you convince yourself that hedge funds are actually successful at providing these services reasonably reliably, it's such a indirect and small contribution to society that it's hardly justification for picking quant finance over a different industry.

(I really don't think that making the investors richer is a particularly strong moral justification either, even if you are an adamant believer in the capitalist system.)


For me, the only possibly justification for working in finance is that I have some ambitious goals in life (regarding contribution to society), and I don't think that directly getting a PhD and finding a research job will put me in a position to achieve those goals. So I want to work in finance in order to give myself a platform for the stuff I want to do later on.


And as fedja said, ignoring the moral question you raised, financial math is pretty interesting. I really liked the stochastic analysis class I took. So it shouldn't be an unpleasant job.

[John622]

I was talking to some other students about it and found some justifications:

1. The "trading" portion of financial math helps to make the market more efficient by removing arbitrage opportunities.
2. The risk management, derivative valuation portion helps investors to better understand the risk they are taking. There will always be risk involved in finance, but a better understanding of what the risk is allows people to make more informed decisions. A lack of understanding of CDOs contributed to the recent subprime meltdown.

I think the second point is the clinching argument. That financial math is not a "crystal ball" for predicting the stock market, but rather it helps investors take more informed risks. So it contributes information about investment.

The first point mainly applies to algorithmic trading/ quant trading types.

[gauss202]

The macroeconomic argument could be made that quantitative financial analysis contributes to the understanding of how financial markets bahave. This in turn allows society to make better judgements about what to do with its capital, investments, and savings. It also causes greater efficiency in markets, and causes greater national/global productivity and return on investments. All of these are things that ultimately fuel progress and invention, and (arguably) improve society as a whole.

Whoops, just saw that you came to the same conclusions as I did. I don't think as Xevarion does that these are small contributions. Financial markets play a very direct and very important role in the economy as a whole and in people's lives. They effect everything from pension funds, to housing markets, to interest rates.

[fedja]

[blahblahblah]

a couple of examples:

the pensions of union members may be invested in a hedge fund or investment bank. quants are (at a certain level) responsible for the steady growth of said workers' retirement fund.

foreign companies (say, biotechnology companies) may be working with a non-us or non-euro currency. the currency risk that they incur can be mitigated by the work done by quants, allowing the aforementioned companies the best possible chance of completing products which can raise people's standards of living.

gauss202 also raises some good points.

[fedja]

[John622]

I think perhaps we should look at the role of hedge funds as a larger system of gas particles rather than talking about the contribution to society that a SINGLE hedge fund makes. I think the SYSTEM of investors and hedgies contribute to the market by

1) Driving prices to the correct value. If prices are more "correct" i.e. in line with their demand, then the resources in society will be more quickly distributed to the right areas. If there is a lag and things are out of price, then the resource adjustment won't happen as efficiently. For example, if some how 286 computers are still worth \$1000 a piece, then all the major companies will suddenly only produce 286 that nobody needs.

2) They invent new derivatives and products that better meet the risk profile of investors. For example, by having things like basket default swaps, people can "isolate" the credit risk of a company but not bet on the operational risk of the company.

Now, no investment bank and hedge funds are founded to serve these two principles. What's amazing is that by pursuing their own greed, they are in fact performing those two tasks as a SYSTEM. Every win and loss means an adjustment to the market system. It's hard to explain what contribution one single hedge fund makes by winning 5 billion dollars on writing credit default swaps, but together, all the hedge funds synergetically function to make the market function.
The analogy is if you are a car part manufacturer, it's hard to see how this one part contributes to society outside the context of it being part of a car, but you have to realize that this car part manufacturer is part of a much larger system that contributes to society.

I'm going to take a financial economics course and see if I can learn more. My first research survey will be on whether the market/economy has benefited from derivatives and whether profit-seeking strategies in investment is aligned with the improvement of the whole economy.

[John622]

Also we have to look under the larger theme of "do other professions ultimately contribute to society? or do they merely exists due to imperfections in human society?"
For example, professions like police, locksmith, lawyers ultimately are wasteful. They only contribution they make is keeping other people in line with current social order. If people can be more disciplined and adhere to social order without external pressure, then these people can be diverted to more productive jobs.

I think the alternative to free market is communism. That didn't work out well.

[t0rajir0u]

[John622]

I thought mathematicians are philosophers.

[t0rajir0u]

I mean that I've noticed students of math have a tendency to talk about the social sciences in similar terms as the terms they use to talk about the physical sciences. Please let me know if you think I'm being rude; this is merely an observation I've made about a certain type of person. Have you studied sociology? Psychology?

[fedja]

[t0rajir0u]

It seems to me that the primary focus of psychology these days is offering ways to interpret the results of neuroscience, and it is in that interpretation that I would distinguish the methods of psychology as a social science from neuroscience as a "physical" science. Behavioral psychology is very empirical, that's true, but there's a lot more to psychology than behavioralism

[Dominic Connor]

Quant help in the efficient allocation of capital and other resources.
We are in a period of time where the increase in such efficiency is easily the most massive factor in the improvement of living standards of people on Earth.

We only have to look at huge failed countries like India and China to see what happens if you don't have functioning capital markets.
The socialist fascists who run China are just so proud that their economy is now 4th in the world, having just over taken Britain. A country with 1/20th the population.
India adopted a less evil form of socialism, and murdered a vastly smaller % of their population, and given time it may get into the top level by size.

Both are growing fast, but that is the relief you get when you stop banging your head against a wall.
When your people get jobs in the global market because they earn vastly less, you have failed, not succeeded.

The biggest marginal return you get from education is learning to read, after that the marginal value only ever goes down. Same with economies.

China gets a large % of it's relative growth simply because the number of university graduates it murders per year is now only 100 times that of a civilised country.
India has reduced it's bureaucracy and now invests nearly enough in education. It's overall efficiency is now nearly as good as the more backward parts of Mexico.

Already we are seeing structural issues in the Chinese economy driven by the fact that capital allocation is done by political connections not some combination of risk and return.

Of course the credit crunch is a dreadful mess, but western government are responding to it by various economic measures, unlike China which would murder a few thousand people as scapegoats, or India which would let them starve.

[rrusczyk]

[John622]

Dominic Connor,

Your perception of China as a "socialist" country is clearly a sign of your anachronism on the matter. China was very socialist about 20 years ago, it was a command economy where all production were based on what the party demanded. Ever since Deng Xiaoping in the late 1980s, China has reformed its economy into one of the biggest free market in the world. In fact, it is too free. There are many loopholes and regulation deficiencies which allows the capitalists in China to greedily exploit the working class. The Chinese market is more capitalist than the United States. China needs more regulations now to shorten the wealth-poor disparity and add stability to its capital markets.
The "murdering" of university graduates is one of the most, interesting shall I say, that I have heard from China/India bashers so far. Would you please elaborate who does the murdering and what your sources are?
I don't see how a discussion of quant's contribution to society has quickly led someone like yourself to delve into a tangent of rage against two rising powers: China and India. It is perhaps advisable for your own survival in the 21st century to have a more correct perception of these two rising states.

Sincerely yours,

[Dominic Connor]

China still is highly socialist, you don't have to reduce the amount of socialism in a system to make it vastly less awful.

China is no an open market for capital, that isn't hurting it all that much yet, it will soon.
I am entertained by the notion that more regulation leads to more stability. I appreciate that economic history isn't part of many mats curricula, but what you are seeing is the substitution of many small shocks for a smaller number of bigger ones.

It's true that the people running China have more contempt for the working classes than Americans or Europeans but leaving aside morality that simply is not efficient.

As for state murders of graduates I commend you to Amnesty International, or indeed any news media of any kind. Again, that is not efficient, as the Nazis found when they gassed the people who might have made their atomic bomb in WWII.

Financial markets are an expression of the "freedom" in a culture. It is not coincidence that efficient markets are only to be found in democracies. I came into financial markets when my ethnic group was not only out of favour, but occasionally blowing up banks.

But most of us were nice and useful people, honest...
Imagine what would happen if a Tibetan applied for a senior job at a Chinese bank. OF course since he would not have been allowed to go to university that's not likely, is it ?

Again this is not a moral perspective, but an efficiency term. China is a dismally poor country because it does not manage any of its resources well, be they physical, financial or human.
That's what it means to be a rich country, doing what you do well.

[fedja]