By Stephen Blyth
Almost exactly 20 years ago, on 19 October 1993, the US House of Representatives voted 264 to 159 to reject further financing for the Superconducting Super Collider (SSC), the particle accelerator being built under Texas. Two billion dollars had already been spent on the Collider, and its estimated total cost had grown from $4.4bn to $11bn; a budget saving of $9bn beckoned. Later that month President Clinton signed the bill officially terminating the project.
This was not good news for two of my Harvard roommates, PhD students in theoretical physics. Seeing the academic job market for physicists collapsing around them, they both found employment at a large investment bank in New York in the nascent field of quantitative finance. It was their assertion that derivative markets, whatever in fact they were, seemed mathematically challenging that catalyzed my own move to Wall Street from an academic career.
The cohort of PhDs in science, technology, engineering, and mathematics that moved to finance from academia in the early 1990s (a cohort I have called the “SSC generation”) sparked a remarkable growth in the sophistication and complexity of financial markets. They built models which enabled banks and hedge funds to price and trade complex financial instruments called derivatives, contracts whose value derives from the levels of other financial variables, such as the price of the Japanese Yen or a collection of mortgages on apartments in Florida. They created a new subject, known as financial engineering or quantitative finance, and a brand new career path, that of quantitative analyst (“quant”), a vocation that became so popular — for its monetary rewards certainly, but also for its dynamism and innovation — that by June 2008, 28% of graduating Harvard seniors going into full time employment were heading to finance.
However, just as some investors in 2007-2008 were questioning the inexorable rise in house prices and the potential for a market bubble, so too were many students questioning their own career choices, sensing the possibility of a career bubble. As Harvard University President Drew Faust said in her first address to the senior class in June 2008, “You repeatedly asked me: Why are so many of us going to Wall Street?”
Three months later, both market and career bubbles collapsed as Lehman Brothers filed for bankruptcy. In the midst of the financial crisis, on 3 October 2008, the House of Representatives voted 263 to 171 to pass the Emergency Economic Stabilization Act, authorizing the Treasury secretary to spend $700bn — roughly 65 Super Colliders — to purchase distressed assets.
What went wrong? While the causes of the financial crisis have been widely debated, it is clear that many financial engineers were caught in what I have termed the “quant delusion,” an over-confidence in and over-reliance on mathematical models. The edifice of quantitative finance built over 15 years by the SSC generation was dramatically rocked by the events of 2008. Fundamental logical arguments that practitioners had taken for granted were shown not to hold. Decades of modeling advances were revealed to be invalid or thrown into question.
It is hard to prove a direct causal link between the cancellation of the SSC, the rise of financial engineering, and the chaos of 2008. However, if some roots of the financial crisis can be traced, however distantly, to October 1993, might one consequence of the financial crisis itself be a healthy reassessment of career choices amongst graduates?
I encounter evolving attitudes among students in the class that I teach at Harvard, Statistics 123, “Applied Quantitative Finance”. Many still plan a future on Wall Street, and are motivated by the mathematical challenges and dynamic environment ahead of them. Some are interested in the elegant mathematical and probabilistic theory that underlies derivatives markets, and are keen to understand the way of thinking that exists on Wall Street. Others appreciate that they have a broad range of equally compelling career options, whether in technology, life sciences, climate science, or fundamental research, and take my course simply because they have enjoyed their introduction to probability and want to experience one of its most compelling applications.
Stephen Blyth is Professor of the Practice of Statistics at Harvard University, and Managing Director at the Harvard Management Company. His book, An Introduction to Quantitative Finance, was published by Oxford University Press in November 2013.