Masters in Business

Quant Finance Run Amok

The formulas lead to overconfidence, resulting in bad outcomes.

What happens when you create a quadrillion dollars out of thin air, and then blow it up? The answer, says Paul Wilmott, a quantitative finance expert and this week's guest on our Masters in Business podcast, is you have a structural problem and potential financial crisis. He should know: He is the author of various texts on quantitative finance and risk management of derivatives. (That quadrillion dollar reference is the notional value of worldwide derivatives contracts.)

Wilmott isn't quite an academic, nor is he a pure practitioner of the quantitative arts. But what Wilmott really wants you to know are his thoughts about the quantitative models he and others have created. The positive side of the ledger is that they are the “engine room of the global economy.” The negative? They were “the cause of its most recent meltdown.”

Wilmott says that quantitative investment models, as currently deployed, are a “pseudoscience” and that the quant community has “misled generations of economists and investors.” The problem, he says, is that financial models seem to make traders and managers overconfident, which leads to bad outcomes. The credit crisis was one of those, and to hear Wilmott describe it, not much has changed: Incentives remain misaligned and no one responsible went to prison. These issues make another quant-driven crash inevitable.

You can stream/download the full conversation, including the podcast extras, on BloombergiTunesOvercast, and Soundcloud. Our earlier podcasts can all be found on iTunes, SoundcloudOvercast and Bloomberg.

Next week, we speak with Jim Ross, chairman of State Street Corp.’s SSgA Funds Management Inc., which among other things devised the Spyder family of exchange-traded funds.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

    To contact the author of this story:
    Barry Ritholtz at

    To contact the editor responsible for this story:
    James Greiff at

    Before it's here, it's on the Bloomberg Terminal.