Physicists, models, and the credit crisis

The New York Times had an article last week on the cadre of physicists that became quants in the financial industry (sub. req.). It features a refrain that echoes in just about every article about the credit crisis: models that worked, until they failed:

Another consequence is that when you need financial models the most — on days like Black Monday in 1987 when the Dow dropped 20 percent — they might break down.

I remember working in The City in the late 90’s and Wall Street in the early 00’s and remarking then that just about every quant had a physics or engineering background. I met very few statisticians. (Had there been more, it would have been easier to sell the merits of S — my job at the time — versus Matlab which along with Excel was endemic.) Quantitative models have taken a hefty share of the blame for the credit crisis, but I wonder whether the blame lies more in their application, rather than the models themselves. Statisticians are trained on the limitations of models (Box: “all models are wrong, but some are useful”), and how to detect when models are breaking down, but statisticians were woefully underrepresented amongst quants. Do physicists and engineers get si…

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Another consequence is that when you need financial models the most — on days like Black Monday in 1987 when the Dow dropped 20 percent — they might break down.