Quantitative finance is the application of complex mathematics to solve financial problems. The practice is used in mitigating and managing risk of complex financial instrument portfolios. Being able to view a problem quantitatively is the first step in solving that problem. In order to develop the proper solution, one must fully understand the problem, and its implications, at hand. The important consideration here is that aspiring quants must understand the financial services industry.
Becoming a quant takes more than having the appropriate title on your business card. There are a number of ways would-be quants can acquire the right skills and knowledge base necessary to succeed in today’s financial markets. The first step is to make sure that your mathematics background is as strong as possible – stochastic calculus should be a part of that background.
Secondly, you should seek out a specialized training program, such as the Certificate in Quantitative Finance (CQF). The CQF, launched in 2003 by Dr. Paul Wilmott, gives you practical, real-world instruction on the issues and problems you will face on your job. CQF instructors are people who have actually worked as quants – offering workshops that go beyond just learning and repeating standard theories.
Finally, you should work to develop your programming skills, which are another vital aspect of a quant’s job. A quant must be able to put together a model that will track or predict specific market parameters (such as interest rates or volatility) and, based on that, price complex derivatives contracts. Programming is crucial for testing and implementing any such model.
Although quants are often bundled into one large category, there are many different forms and functions within quantitative finance, across risk and trading. A common risk measure, Value at Risk (VaR), has been used to determine the level of risk a financial institution is facing. Of course, its calculation uses certain assumptions, and expressing the numbers in even simpler form (as in a “one in 2000 event”) reflects an underlying belief in a normal distribution (a bell-shaped curve), which may not be the most accurate representation. Some quants are working on proposing different distributions to model underlying processes.
After the onset of the financial crisis a year ago, risk management became a high priority for many firms. Quants working within risk management are now finding that their efforts receive greater attention and play a more crucial role. The actual risk management work has not changed fundamentally, but rather more of it is being done.
Since the crisis, quants have gotten a lot of bad press over the past year (unfairly, I believe) as the world searched for a scapegoat to shoulder the blame for the financial downturn and resulting recession. In January, Wall Street Journal reporter Scott Patterson wrote an article suggesting how a swashbuckling class of mathematicians and computer scientists were at the heart of the financial meltdown. In his Wall Street Journal piece called “The Minds Behind the Meltdown,” Patterson includes excerpts from his book “The Quants: How a New Breed of Whizzes Conquered Wall Street and Nearly Destroyed It.” The article focuses on quants and seems to ignore the entire real-estate meltdown that preceded and triggered some of the trades.
Despite the bad press, there will always be a place for quants in the field of finance. Quants play an important role in integrating complex math into the field of finance – not just in creating instruments or new trading strategies, but to support and manage the risks and operations of the increasingly complex financial services industry.
The financial industry has problems that quants can help solve, like measuring and managing risk. It is crucial though to have a common-sense approach about the problem at hand. In the end, the issue is not an academic debate about which model is better, but about how close the model is to reality, and how well you manage to protect the company from incurring losses.
Constantin Cazacu is a Hedging Consultant with the RGA Reinsurance Company and holds a PhD and CQF.
