A Word on Quants

Those who have criticized ‘quants’ for causing the financial crisis should read “The world’s largest hedge fund is a fraud” (PDF, hat-tip to Wikipedia) by Harry Markopolos. The first two paragrpahs:

I am the original source for the information presented herein having first presented my rationale, both verbally and in writing, to the SEC’s Boston office in May, 1999 before any public information doubting Madoff Investment Securities, LLC appeared in the press. There was no whistleblower or insider involved in compiling this report. I used the Mosaic Theory to assemble my set of obserations. My observations were collected first-hand by listening to fund of fund investors talk about their investments in a hedge fund run by Madoff INvestment Securities, LLC, a SEC registered firm. I have also spoken to the heads of various Wall Street equity derivative trading desks and every single one of the senior mangers I spoke with told me that Bernie Madoff was a fraud. Of course, no one wants to take undue career risk by sticking their head up and saying the emperor isn’t wearing any clothes but…

I am a derivatives expert and have traded or assisted int eh trading of several billion $US in options strategiesfor hedge funds and institutional clients. I have experience managing split-strike conversion prodcuts both using index options and using individual stock options, both with and without index puts. Very few people in the world have the mathematical background needed to manage these types of products but I am one of them. I have outlined a detailed set of Red Flags that make me very suspicious that Bernie Madoff’s returns aren’t real and, if they are real, then they would almost certainly have to be generated by front-running customer order flor from the broker-dealer arm of Madoff Investment Securities. LL.

Markopolis’ leter (which was written in 2005) shows quantitative evalulation in fine form, providing converging evidence to demonstrate that some claims can not be. Indeed, “mosaic theory” looks an awful lot like mxied-methods convergent-validity research.

Blaming ‘quants’ for the financial collapse is like blaming ‘accountants’ for Enron’s collapse. If you pay people to do something other than be wise, you increase how often they are foolish.

Indeed, the greatest ponzi scheme in history was not caused by quantitative methods, but old fashioned affinity fraud where a member of a community tricks other members of the same community through trust.