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My Life as a Quant: Reflections on Physics and Finance

Emanuel Derman

posted on 14 March 2007

reviewed by Joseph L. McCauley

After reading Derman's Platonic idea of the origin of physics on the first two pages, I was so angry that for a while I couldn't read further. When finally I did read further, I couldn't put the book down until midnight. This autobiography of a physicist turned financial engineer is more entertaining than most novels, and is informative in a way that no other book is. Derman's description of his life and times is the chronicle of an era. This is a book that should be read by physics grad students who fantacize about working for banks or trading houses.

I remember how in 1957 we and our neighbors went out at night to watch Sputnik pass overhead as a pale, visibly moving light. This was the same year that Mercury had produced the 6 cyl. 60 h.p. outboard motor, Chevy produced its classic model, Elvis sang 'Loving You', and my youngest brother was born. Then, each morning before school, we would turn on the Today Show and often watch as a rocket from Redstone Arsenal (Huntsville) or Cape Canaveral went up a few meters, then fell over and crashed. Finally, von Braun (who'd escaped from Penemünde via Thüringen to North Tirol (where I mainly live) and then engineered his capture by the U.S. rather than the Russians or the French) eventually got it right and launched too, but not before Americans were treated to huge, Life Magazine photos of Chicago teenagers jitterbugging their lives away, and of Russian teenagers intensely studying math and physics. The US reaction to Sputnik was in part the NDEA loans that got me and a lot of other science majors through the university, and produced a very large excess supply of physics Ph.D.s by about 1970. In the seventies, academic jobs in physics in the US were so few, and the competition so great, that it was the kiss of death to take a postdoctoral fellowship in Europe. Going there put you outside the loop. One could generalize a British postdoc's experience after his arrival at Cal Tech in the following way: the US was the center of the universe in physics, and to a first approximation Europe did not exist. In the early eighties I noticed that a former physics grad student in nonlinear dynamics been hired by a trading house. I didn't understand the significance then. Eventually, one of my later to be closest collaborators (and is Feigenbaum's only grad student to boot) worked for a year in 1990 at a Chicago trading house before coming to the University of Houston. In 1999, the same year that I heard of the Physics and finance meeting in Dublin where Gene Stanley coined the awful but effective term 'Econophysics', I read that Mitch Feigenbaum and Nigel Goldenfeld had opened a derivatives-related business in New York. Derman was one of the first physicists to go to work as a modeler on Wall Street. Derman's book, written humorously, self-deprecatingly and introspectively, yet objectively, is a chronicle of that era, a chronicle of physics and job hunting by physics grads in the post-Vietman war era, the era that began with Nixon's deregulation of the dollar (tied to gold at $35/oz. from 1935-1971, gold that Americans were not permitted to own for reasons of attempted currency stability). I'll stop here with my introduction and recommend that anyone who really wants to understand something about the world financial system read Eichengreen's `Globalizing Capital'. Here are some comments about parts of the book that I liked particularly well, or particularly disliked. The book can be read as a useful complement to `The Predictors', Liar's Poker', and `Inventing Money'.

The platonic view of the origin of mathematical laws of nature expressed on the first two pages is wrong. One can understand how a theorist with a focus on gauge theories might get on that track, but it is not true that Einstein thought that way in his early discoveries. For a better picture of why mathematics is unreasonably effective in physics, read Wigner's `Symmetries and Reflections', and read Barbour's `Absolute or Relative Motion' for the history of the discoveries.

The difference between physics (academic research) and financial engineering (on the Street) is described pretty well. In the latter, a good graphics interface is more important for business than is a good model. The description of the difference is generally true of physics and engineering per se, and is not peculiar to the financial brand.

The description of reductionism is the extreme brand believed uncritically by people like Steven Weinberg. Any correct mathematical description of nature, any isolation of cause and effect, is a form of reductionism. Attempts to understand markets empirically is a form of reductionism.

The description of Lee and Yang's quarrels is revealing (both visited the University of Houston Physics Dept. at various times in the seventies and eighties). The description of Cvitanovic rings too true! I was not aware (!?) that Feigenbaum and Libchaber (name misspelled) like Steiner's writings, although it's fairly well known that Feigenbaum reads Goethe.
Derman describes vividly how no one can get past T.D. Lee in a colloquium, then with British understatement writes that his own thesis defense, with Lee on the committee, was no problem. And his advice to students about blind alleys and perseverance is correct. The race is often won not by the quickest but rather by the one who doesn't quit in the face of adversity.

The author had a tantalizing taste early on of the life of the successful (i.e., well-connected) physicist on the conference circuit. I myself read too many biographies of German professors who took a Kur for 6 weeks on the Baltic or the North Sea.

His description of life at Oxford, and the string of postdoctoral positions is believable and hilarious. The description of the pain of having to live apart from his wife and son is painful to read, although many physicists live so.

Derman also describes what makes physicists arrogant without naming it: life in a scientific culture where the standards are set by certified geniuses. It's hard to live in the shadow of these people. One learns a certain degree of arrogance merely for survival in the culture, and that makes us hard to live with at home and in society. Advice from a bright colleague how to get along with your partner: 'grovel, grovel, grovel'. It works.

His advice about publications is absolutely right: it rarely hurts to put a collaborator's, host's or advisor's name on a paper. I contemplated publishing my thesis alone because Onsager had not really contributed to it, although he suggested the problem. Actually, I doubted that he wanted his name on such a seemingly trivial piece of work, but it turned out that he liked it. He liked all sorts of calculations. As long as they were right ...

There is no correct analogy between economics/finance and thermodynamics, the far from equilibrium nature of markets prohibits it. Fischer Black, whom I admire enormously and have read carefully, was wrong about 'equilibrium': he swallowed the economists' notions uncritically Derman describes Black as 'in love' with the idea of equilibrium, and one can swallow anything when one is in love). CAPM is certainly not an 'equilibrium' model, and CAPM does not lead to the Black-Scholes pde, there's an error in the 1973 paper. I prefer the Black-Scholes paper to all of Merton's useless rigmarole about utility, a nonfalsifiable notion at best, although it's true that replication is not in the Black-Scholes paper. I can't see that Merton's derivation of the backward time pde is `more rigorous' than Black's delta-hedge condition.

Derman's description of his self-imposed exile to Bell Labs is hilarious. His loving description of UNIX is beyond me (I know how to use a word processor).

Weltanschauung is mis-spelled, there are n+1 split infinitives in the text.

Now I know where Lisa Borland's boss comes from.

The description of Fischer Black is worth the book alone, even if the rest were not good. Osborne, Black, and Mandelbrot can be counted as the ancestors of Econophysics, which differs from Financial Engineering the way that physics differs from engineering. Black was right that expected returns, seen as anticipating the future, is not an observable notion. But, then, what does Soros do when he beats the market (nonmathematically)?

Derman's description of economic theory as nonsense (my term) is absolutely correct, when applied to micro- and macro-economics texts. What one finds inside those books is useless, falsified mathematized ideology. To make matters worse, economists know that and still teach the stuff in the classroom, misleading generations of students.

All in all, this is a highly recommendable book!