When it was suggested to me to write a paper on the development of quantitative finance for the Next Finance website I must admit I was surprised. Indeed, even though I was financial professional, It was not that easy for me to define the concept of quantitative finance. What exactly is Quantitative Finance ? A quick look on the web reveals that the term is often used in professional or academic fields. I realised, therefore, that I must be one of the few to have a problem defining that concept: the job had to be done and I accepted the proposal.
HOW DOES ONE DEFINE QUANTITATIVE FINANCE?
A simple definition might be in a field of finance, which is characterized by the use of quantitative tool, as opposed to conventional finance based on fundamentals. Why not! But then, what about the fact that those fundamentals are measured and are assessed using aggregated numerical data or statistical techniques belonging to the quant world ? Well let’s be more precise. Quantitative finance would be an area of expertise in which decision making is based on mathematical models or and/or models of Physics . Is it clear now? Not really! Are there other fields in which the use of mathematics and physics have left such a strong impression? Econometrics certainly exists in the Economy field but with one significant difference: Econometrics is first considered as part of the economy, while quantitative finance is first seen as quantitative science prior to be "finance". Finally, rather than looking for a global definition, it might be better to review the profile of the so-called "quants" in France in order to eventually end up with a global description.
THE «QUANT» IS A MATHEMATICIAN.....
The word "quant" was primarily used in France to describe a population of financiers working in investment banking, more specifically in the business of structuring and pricing of derivative products. The activity soars in France in the 90s and lead very quickly to a total craze. Thus, a good number of students, from various background, want to become quants
Each year, more and more young engineers or science graduates are interested in this career. But how does one become a “quant” ?
Yann Olivier’s article published on this portal describes very well this phenomenon. The article shows the potential positions of a quant within a bank. One must also add that at the time, carreer in research was not high on the agenda, and young talented mathematicians saw an opportunity to take advantage of the financial windfall available in financial markets for talented quants. French Investment banking activities flourished under the influence of their quant. A large part of the reputation of some of French bank relies on these activities.
Not only young students, French leading scientists produce great works in the field of mathematics applied to finance. Nicole El Karoui, Bruno Dupire and many others have become academic authorities in the field, as well as international celebrities such as Paul Wilmott.
THE QUANT IS ALSO AN IT DEVELOPER
In France, many financial engineers feel some aversion for IT. Some, fascinated by models, don’t consider for a second writing thousands of lines of code…
Very quickly, going beyond the abstractness of the intellectual modelling, people want quants to implement their ideas. The transition seems to be a little more difficult for the French quant as the article of Yann Olivier bears witness. He concluded with the following sentence: The quants of tomorrow will be more than ever, without a doubt, "informathematicians!". Note that the introduction of ’mathematical framework’ in finance comes with heavy IT developments and even leads to the creation of new roles: The "commandos". These are IT developer with a "special mission" , to be able to understand algorithms and implement them in a relatively short time. This middle man position, between mathematical modeling and the use of outcome, turned those IT guys into an essential of the process and, eventually, they fully became member of the quant world. Anglo-Saxons do describe them with the words Quant developer.
AND FINALLY A PHYSICIST
If the mathematicians make their way in investment bank by designing and selling ready-to-use solutions to customers, physicists find their niche in asset management. Indeed, quants in investment banking think about a problem needs to find a solution to a given date (corresponding to the sale of the product). Those in asset management must make sure that they have found long-term solution (though not necessarily optimal on a given date) and, otherwise, continuously adapt to manage the assets as investors are likely to subscribe (or redeem) at any time.
According to Fabrice Foy, Quantitative Analyst at CCR-AM, we should do the exact opposite of the classical theory: the stock price does not reflect fundamentals, and if it deviates from its fundamental value, it does not necessarily tend to revert (...)
This adaptive approach towards the uncertainties in an evolving market, is very similar to that of a physicist and explains the huge success that physicists have in the portfolio management field.
A good illustration of this potential link between Physics and Finance is given by Fabrice Foy in his article that was published on this site: "To Predict or to adapt". The article goes even further and leads up to an evolution in quantitative finance which we shall address in the final analysis. In France, the success of the quantitative approach in asset management is actually illustrated by the firm Capital Fund Management (CFM). This Hedge Fund exclusively uses quantitative strategies under a scientific committee lead by physicists!
QUANT: FROM HONEYMOON TO DIVORCE
After having been at the top and often considered as "the financial elite", the quants whether they are in investment banking or asset management have been facing a tough period, not yet over today.
With the losses recorded by one fund of top quant manager, Renaissance Technologies, and three other funds of Goldman Sachs, the quantitative management industry might be facing its first real crisis.
It all (almost) starts ( at least going public) in August 2007 with a storm over quantitative funds. Shortly before, it was being discovered that ultra quantification had led a handful of quants in investment banking to lack rigor in the design of model assumptions. The crisis is global and raises the first questions on quantitative management and in particular the risk assessment of the models. The critics attack strongly from all sides. They even cover the voices of academics who had anticipated the shortcomings as well as innovative approaches:The damage is done and the breakdown is real, especially as the public is shocked to find that local governments, in a search of easy money, have succumbed to the lure of the structuration without really understanding embedded risks.
TOWARDS A COMEBACK OF QUANT WORLD
Quants did not (Hopefully) give up. The structuration activities continue to globally be low profile in France even if they are still some deals here and there. The quantitative management industry, which has pretty well weather the crisis, made the choice to to get together and set up lobbies in order to better protect their interests while improving the quality of service. The associative project QuantValley is a perfect example
Challenges, positioning and quantative management outlook in France. Arnaud Chrétien and Serge Darolles, respectively Chairman and deputy chairman of QuantValley, answer our questions and introduce us to their project aimed at promoting Paris’ image as a city of (...)
However, the task will not be easy. The regulator, whose role is essential for the proper functioning of financial markets, is increasing its interventions in order to reduce the remaining pockets of resistance of the "quant monster". This is done sometimes to the detriment of some consistency as showed by the article High Frequency Trading (HFT): Positive for forex market and negative for equities ?
Beyond an organic resistance, a change in the world of quants is noticeable. The Quant world evolves, in a way inspired by investment banking and traditional asset management as both decide to improve their image by orientating development towards more socially responsible products for the former, and SRI portfolios for the latter. The quant solution can be explained as follow: one of the main criticisms of ultra-quantification is the dehumanization which results in a de-connection with reality. Today, as Fabrice Foy mentioned in his article previously quoted, quants now reintroduces the human bias by the use of behavioural finance! Quite a programme! Browsing this website will let you learn a little more about it. One will see that the concept is not new (and is therefore not simply a fashion statement) as Emmanuel Regnier underlines by signing the article From the Dutch Tulips Mania to the panic of 2008... or Michel Verlaine in the article: Towards a behavioral portfolio theory
The following thoughts of Mory Doré is a perfect conclusion
I recently read in a magazine that to be a good financial market professional in research, trading and structuring, you had to be: a good mathematician, a good physicist and computer-savvy. Being able to be all at once is perfect while this does not prevent from deepening knowledge in the field of behavioral finance.
Mory Doré
EPILOGUE
Although It is still not clear (at least for me) to give a global definition of quantitative finance, I do believe that the existence of the quant is legitimised by strong fundamental reasons. Here are three:
The criticism leveled against the quantitative world is not based on the scientific knowledge but on the abusive use of that knowledge. So the foundation of scientific knowledge is still valuable ( and it could not be otherwise, as the same foundations are used in other domaines outside of finance) one must just use it with a plausible assumptions
If the current crisis (labelled as the subprime crisis) has highlighted the complexity of structured finance along with the necessity of developing more sophisticated risk management tools, it appears that a great deal of misunderstanding still prevails among economic and (...)
The actual financial analysis spectrum ( many parameters must be taken into consideration), is too vast to imagine covering it without quantitative analysis tools. On this specific point, I do agree with a senior executive of Société Générale who argued during an interview on this site: « The fact that some products are complex is not just to make banks happy. The point is, how can one solve a complex problem using a linear solution? » and I invite the reader to reread the excellent article written by Michel Verlaine on structured finance (see description on the right). Complexity often comes from an expression of need and not necessarily from the suggested solution. Besides, not only the market operators but also the regulator use quant tools in order to follow operations (thus, the regulator uses the tools that it often condemned in the first place)
Finally, the use of quantitatives helped to "normalize" the evaluation criteria and to facilitate internal control procedures. This may come as a surprise, but it is also a reality. Quants work in a predefined well known scientific framework (regardless of backgrounds and cultures). Thus, any quant can resume (at least in theory) the study and revalidate assumptions. The quant has ended a period of bias specific to the manager/star analyst and replace by the systemic bias of science
