Thursday 26 March 2009

Maths and the Markets

The Turner Review of Financial Services Regulation identifies one of the causes of the financial crisis as a "misplaced reliance on sophisticated maths". The FT was quick to criticise this naive and ill-informed view.

The banks that failed seem to have abused maths, financial firms that succeed use maths.

Take for example BNP Paribas, Bank of the Year in 2008. The lead quant is Prof Marek Musiela, a well regarded research mathematician who would be snapped up by the maths department of any prestigious university. In employing Prof Musiela, BNP is setting the culture of the company.

Much of financial innovation is coming out of hedge funds, and while these "shadow banks" come in for some criticism, a number of hedge funds were created by the frustration innovative scientists felt working in the blue chips banks (which are failing).

Last year's top earner was Jim Simons, who runs Renaissance Technologies. Jim is another research mathematician, having won the American Mathematical Society’s Oswald Veblin
Prize in Geometry. A third of Renaissance's 200 staff in its main offices have PhDs and one senior manager is quoted as saying “I’ve always said Renaissance’s secret is that it didn’t hire MBAs,” - i.e. it does not hire "finance" experts, it hires scientists.

In the UK, while the MAN Group has posted a halving of profits (on a falling market), their share price rose, the reason being they did better than expected. The MAN Group takes maths so seriously they fund Oxford University mathematicians, drawing world-leading researchers to Oxford and into dialogue with the hedge fund. Not only does this give MAN and edge, but it gives the UK as a whole an edge by being a "brain sink" rather than a "brain drain".

Have these leading firms really been getting their use of maths and science wrong? Anecdote is not evidence, but while RBS was investing millions in "sports ambassadors", BNP, Renaissance Technologies and the MAN Group were all investing in mathematics and science. The impact of these two strategies appears obvious, and investors should bear this in mind in the future.