MY LIFE AS A QUANT
Reflections on Physics and Finance
By Emanuel Derman
Wiley; 292pp; $29.95
Indecisive, introspective, awkward, and sometimes morose, memoirist Emanuel Derman comes across like a character in a Saul Bellow novel. He wallows in loneliness after leaving his home in South Africa to earn a PhD in theoretical physics at Columbia University. Later, he obsesses over leaving pure physics to do applied research at Bell Laboratories. Then he punishes himself with guilt when he abandons physics entirely to work on Wall Street. Although he succeeds as a math-savvy "quant" at Goldman, Sachs & Co. (GS ), he continues to ponder whether markets can really be understood. "We are still on a darkling plain," he writes toward the end of his new book. "If you are a theorist you must never forget that you are traveling through lawless roads where the local inhabitants don't respect your principles."
That sense of being an intruder in outlaw territory lends an intriguing mood to Derman's My Life As a Quant, a literate and entertaining memoir of his two-stage career -- in physics and then financial engineering. Wall Street looks quite different from a nerd's-eye view: "Geeks were fair game," Derman reflects. Once, a chief trader who passed between him and a fellow quant "winced, clutched his head with both hands as though in excruciating pain, and exclaimed, 'Aaarrggh-hhh! The force field! It's too intense! Let me out of the way!"'
As one of Wall Street's leading quants, Derman did throw off some intense gamma radiation. He worked at Goldman from 1985 until 2003 except for one year at Salomon Brothers. At Goldman, he moved from fixed income to equity derivatives to risk management, becoming a managing director in 1997. He co-invented a tool for pricing options on Treasury bonds, working with Goldman colleagues Bill Toy and the late Fischer Black, who co-invented the Black-Scholes formula for valuing options on stocks. Derman received the industry's "Financial Engineer of the Year" award in 2000. Now he directs the financial-engineering program at Columbia University.
Derman failed at what he really wanted, which was to become an important physicist. He was merely very smart in a field dominated by geniuses, so he kicked around from one low-paying research job to another. "At age 16 or 17, I had wanted to be another Einstein," he writes. "By 1976...I had reached the point where I merely envied the postdoc in the office next door because he had been invited to give a seminar in France." His move to Wall Street -- an acknowledgment of failure -- brought him financial rewards beyond the dreams of academic physicists and a fair measure of satisfaction as well.
In the tradition of the idiosyncratic memoir, My Life As a Quant is a grab bag of the author's interests. It quotes Schopenhauer and Goethe while supplying not one but three diagrams of a muon neutrino colliding with a proton. There is a long section on the brilliant and punctilious Fischer Black; a glimpse of physicist Richard Feynman; and an embarrassing encounter with finance giant Robert Merton, who sat next to the author on a long flight (Derman treated him rudely before realizing who he was).
Derman's mood seems to vary from bemused on good days to sour on bad ones. The chapter on his postdoc travels is titled "A Sort of Life"; his brief career at Bell Labs, "In the Penal Colony"; his tenure at Salomon Brothers, "A Severed Head." Pre-IPO Goldman Sachs comes off as relatively gentle yet stimulating. He writes: "It was the only place I never secretly hoped would crash and burn."
At times, his awkwardness is so extreme that it's funny. Here's how he failed to work up his nerve to ask a Columbia professor to be his adviser: "Every time I saw him I smiled; every time I smiled he bared his lips back at me with greater awkwardness." It got so painful that he began to flee whenever he saw the prof coming.
The most challenging part of the book -- and for techies, probably the best -- is Derman's detailed explanation of trading tools he developed. The Black-Derman-Toy model, from 1986, allowed trading desks to come up with prices for Treasury bond options based on math rather than guesswork. In 1993 he and Goldman colleague Iraj Kani invented an options-pricing method that improved on an aspect of Black-Scholes -- its incorrect assumption that the volatility of options is unvarying. They deduced the "local" volatility of a conventional option at each possible stock price and at each moment up to expiration. That information could then be used to price exotic options more accurately.
As it turned out, both inventions had limitations in practice, but Derman accepts that. The theoretical purist finds a measure of contentment in contributing to the imprecise world of finance -- "intuiting, inventing, or concocting approximate laws and patterns." It ain't E=mc2, but as he recognizes, it may be the best anyone can hope for.
By Peter Coy