The promise of the book is that it explains why so many physicists (and mathematicians) are employed by Wall Street investment firms. It delivers on the promise, but the answer is disappointing — they are good at math, especially statistics.
The history about “quants” is described. Covers:
- Louis Bachelier: A mathematician who applied the concept of Brownian movement to analyzing price changes in the early Parisian Bourse. Assumes the “efficient market” hypothesis. I.e., stock prices are set correctly by the market. Variations around the correct price are random, and assumed to have characteristics of a random walk — stock prices vary like a Bell curve.
- Maury Osborne: A physicist who also applied the concept of Brownian movement, by to the rate of return rather than the stock price. I.e., a log-normal distribution. Influenced the classic book “A Randow Walk Down Wall Street” by Burton Malkiel.
- Benoit Mandelbrot: A physicist who tied in the Pareto principle. Stock prices vary much more than the Bell-curve distribution. Argued for a Cauchy distribution — a fat-tail distribution.
- Edward Thorp: A physicist who invented the modern hedge fund. He brought in Shannon’s information theory into stock market modelling. His early interests included techniques for card counting in Blackjack and schemes for winning at roulette. Found ways to analyze warrants, an early form of options trading.
- Fischer Black, Myron Scholes, Robert Merton: Mathematicians who developed the Black-Scholes option pricing formula.
- James Doyle Farmer, Normal Parker: Physicists who brought in Lorenz’s chaos model concepts to financial modelling and algorithmic trading algorithms.
- Didier Sornette: A geophysicist who used earthquake prediction algorithms to predict stock market crash events — “dragon king” events.
- Pia Maloney, Eric Weinstein: An economist and a physicist married couple. They have proposed using Gauge theory from Physics to develop better economics models of CPI, etc.
The book has a few paragraphs describing the job prospects for Physics PhD’s in the 60’s and 70’s. The Cold War and space race created a demand for physicists, but after the moon landing (and also due to the Vietnam war) the job market cooled greatly. That was around the time that I graduated with a Physics PhD. My “decision” to become a programmer (software engineer) may have been influenced by this 😉
One thought echo I had reading the book is it reminded me of what I’ve read about Alchemy. Alchemy was the early approach to Chemistry. (Isaac Newton was also an Alchemist). Alchemists were active in the same era where the early formalization of Physics and Mathematics was happening. Those fields made great progress largely because papers were written and shared. Alchemists did not share their learnings — turning lead into gold was too personally valuable.
The parallels to modelling the stock market are also better kept secret.