The Super Quants

Perfectly Reasonable Deviations highlighted an interesting, if old article on D.E. Shaw, so I thought I'd profile three of the super quants of Wall Street for a little inspiration, including Shaw.

Dubbed King Quant by Fortune, Shaw is a billionaire, and made the Forbes 400 list in 2006.  He created a company called D.E. Shaw dubbed by Fortune as  "the most intriguing and mysterious force on Wall Street."  The company employed Jeff Bezos before he founded Amazon, now employs 1000, and supposedly rejects 1 in 500 job applicants.  It is very secretive, but is known to employ statistical arbitrage and more recently, some good old bargain-hunting methods.  Interestingly, he is the son of an efficient markets pioneer (Update: Wikipedia may be wrong, as it may have been his grandfather, not his father - see comments).  His firm, like LTCM had some problems in 1998, losing a bundle ($375 million writedown for BankAmerica, according to Wikipedia). He implied fairly recently that the growth of hedge funds is making alpha harder to find. David Shaw is apparently no longer involved in the day-today management of money, rather he is now  working on algorithms to fight the war on cancer and other diseases.  DE Shaw now manages $23 billion in assets and is making a push into traditional asset management.

Jim Simons is a true math nerd, being a cryptanalyst, mathematical physicist, and even has his own mathematical theory which has use in string theory, a mind-blowing theory of everything. He is ranked as the 64th richest person in America at $4.5 Billion.  He founded the secretive Renaissance Technologies (which was once online, but apparently no longer) that according to Wikipedia:

Renaissance uses computer-based models to predict price changes in easily-traded financial instruments. These models are based on analyzing as much data as can be gathered, then looking for non-random movements to make predictions.

Renaissance employs more than 60 top scientific specialists, including mathematicians, physicists, astrophysicists and statisticians, from countries as diverse as Japan and Cuba ^[3]who review market data to find statistical relationships that predict the price movements of commodities, currencies and stocks. Its $5 billion Medallion Fund has averaged 35% annual returns, after fees, since 1989, and is considered in the industry to be the most successful hedge fund,^[4] yielding returns ten percentage points higher than investors Bruce Kovner, George Soros, Paul Tudor Jones, Louis Bacon, Mark Kingdon or Monroe Trout.

More description of their methodologies is here. He wants to launch a fund that could handle $100 Billion, giving hope that alpha is still to be found in mass quantities.

Ken Griffin is the youngster of the group and started trading in his dorm room at Harvard and eventually started Citadel Investment Group, with $12 Billion under management in 2005.  According to this Bloomberg article:

Citadel employs 72 Ph.D.s, including former mathematics professors and astrophysicists. They are the heart of the firm's Quantitative Research Group, which develops proprietary mathematical models to support traders. They staff so-called Ph.D. Row, the south side of the 36th floor, an area dominated by erasable floor-to-ceiling white boards full of complex math formulas.

...

As more money pours into the industry, performance has dropped, and Citadel is no exception. While Citadel's annual returns, which have averaged 15 percent net of fees since the beginning of 2001, are among the best compared with his firm's peers, they're half the 31 percent Griffin produced from 1991 to 2000. His offshore fund returned about 2 percent in the first quarter.

Citadel was one of the rare buyers in the LTCM crisis, returning 35% that year.  More from the article:

Citadel's four meteorologists sit in front of imaging and mapping computers in an alcove off the trading floor. On a typical day, they might analyze snowpack and rainfall density in the U.S. Northwest to see how a recent increase in precipitation in the region will provide a boost to hydropower producers and, in turn, cut demand for other types of electricity producers.

Citadel has also started dabbling in pollution rights and catastrophe, or ``cat,'' bonds. Reinsurers, such as Swiss Reinsurance, issue these securities to hedge some of the risk of paying claims in catastrophic losses. The bonds pay high interest rates, though investors may lose their principal and interest payments if a storm generates losses at or above a set amount.

Griffin isn't afraid to go into areas untested by other hedge funds. The firm now has a 100-person team that makes markets in equity options for retail brokers such as Ameritrade Holding Corp. and E*Trade Financial Corp.

...

Citadel plans to start making markets in equities in the next few months, says Matthew Andresen, former CEO of electronic trading network Island ECN Inc., who was hired last year to head up the market-making business.

Citadel apparently gives all new hires two books: Hardball: Are You Playing to Play or Playing to Win? and Good to Great.

Update: Much more in another Perfectly Reasonable Deviations post.

Update: Elwyn Berlekamp and Thomas Cover, a possible members of the Super Quant club.

Update: Why are information theorists so successful in the markets? and Super Quants Update.

Comments

[rod.]

Thanks for linking to my blog.

I found your blog a week ago or so, and I must congratulate you for a rather informative and interesting blog! Given that you address many topics that I also have addressed in my blog, I must assume we have overlapping interests.

I am also very much intrigued by whether technical analysis can actually beat the market. I guess that is the ultimate challenge for anyone interesting in applying math to real world situations. Given that many big players in the finance industry have financed research divisions withing their companies, I would say that technical analysis certainly does give an edge on the market, but beating the market might be a bit more difficult.

One topic that seems to underestimated sometimes is the role that computation plays in the process... even if you had the right theory to predict all the market fluctuations, you probably would end up having a highly complex mathematical model, and if you want models to be used, then such models need to be implemented in computers. Having a lot of computer power would certainly help beat the market. That's obvious, but what I find fascinating would be to optimize algorithms and computer architectures to cope with the challenges being faced. It's an extremely difficult task, but alluring still.

[rod.]

This is not very relevant, but still:

in Wikipedia, it is said that David Shaw's father was an efficients market theorist, while in the 1997 article on Wired Magazine ("the phynancier"), it is mentioned that Shaw's father was indeed a physicist. Apparently his grandfather was the efficients market theorist, while his father was also a theorist (plasma physics). Wikipedia is probably wrong on this.

[Alan J]

Rod:

You're most welcome - you have a good one (blog). Thanks for your comment. Looking through all your archived finance posts is on my to-do list. We definately have a lot of overlapping interests!

Beating the market is no easy task, but I think these "super quants" illustrate that it can be done. I am currently coding a computerized system to attempt to do exactly that. It is an alluring, fun and hopefully rewarding task. That said, I'm saving complex math for later, because I think there's some low-hanging fruit around. I'm not sure what you mean by optimization. Optimization of the trading strategy is not high on my list because of the danger of overoptimization. Optimizing the algorithms to run faster is a whole other matter. I think my system will be scalable, and I'll definately install a server farm to compute 24/7 if it can pay for itself, but some optimization will save on the a/c bills ;-).

Thanks for the heads up on D. Shaw's father/grandfather. I'll update the post.

[Charlie]

David Shaw's father was a scientist, his stepfather taught business school but I don't think he is published or a theorist.

[gord]

A floor full of whiteboards covered in differential geome... hmm.. thats a nice place to work.

Information arbitrage, information propagation/diffusion models seem to be todays fad, but I wonder if there ever _will_ be a time when arbitrage is impossible...it would mean we perfectly understood nature, right?

[fad]

Its interesting the methods you are using to make money, good for you for being success, but at the same time the fact that you are using complex mathematics that are hard to regulate makes the morality of what you are doing something to question.