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Once a physicist: Emanuel Derman

Emanuel Derman is a professor of financial engineering at Columbia University, New York, US, and the author of My Life as a Quant: Reflections on Physics and Finance.

Emanuel Derman

What sparked your interest in physics? 
When I was a kid in South Africa I had sort of a transcendental feeling about physics, in the sense that I thought it was fantastic to try to understand the way the world works. Then, as an undergraduate at the University of Cape Town, I found that I particularly liked theoretical physics, and at some point I realized that everybody who was serious about physics was applying to go to graduate school overseas. So I came to Columbia University in 1966, when the whole particle physics revolution was in action. I actually had to start all over again with learning modern physics; I had done my senior thesis on unified field theories in general relativity, but nobody at Columbia was interested in that back then.

Why did you decide to leave academic physics? 
Columbia was kind of a grim place for students at that time, because they let you go on forever; it took me seven years to get my PhD. At the same time, my wife was getting a PhD in biology, and we were moving all over the world; you had to go wherever there was a job if you wanted to stay in the field. After I finished my PhD in 1973, I got a postdoc at the University of Pennsylvania while she stayed in New York. Then I got another postdoc at the University of Oxford, and she eventually joined me in the UK almost a year later. During my third postdoc, we were both at Rockefeller University in New York, and then I got a good job as an assistant professor at the University of Colorado at Boulder. But by that time, we had a two-year-old kid, so my wife stayed with our son in New York (where she had a postdoc), and I just got weary of the whole thing. I think I was also getting a bit disillusioned with the struggle of being a theoretical physicist, but the two-career family thing finally did me in. There didn’t seem to be any way for the two of us to get jobs in the same place.

You then went to Bell Labs. What was that like? 
I spent five years in their business analysis systems centre doing a little bit of financial modelling and a lot of computing. They made you take a sort of quasi-Master’s degree internally in computer science, and I learned a lot of useful stuff, but it was incredibly bureaucratic. In academic life, within some range of parameters, you think you’re your own boss, but suddenly I had somebody who told me what time to come in and go out. Everybody thinks Bell Labs was the world’s greatest place, and for a small percentage of people who were treated as though they were in a university, maybe it was. In retrospect, it wasn’t that bad, but I was a bit spoiled.

What attracted you to the financial industry? 
I kept thinking, “Should I go back to physics or should I go all the way to the real world?” After a while, going back to physics got to be too impractical, but there was a boom for hiring quantitative people on Wall Street, so eventually I decided to go, and I liked it. At Bell Labs I felt like technical talent was treated as a commodity; being a manager was more important. But at Goldman Sachs, even though I was relatively a bit older (about 40), if you could do something well, they appreciated it. It was sort of like you were a theorist and your colleagues were the experimentalists – you spoke to them about their problems and tried to find a theoretical solution. But you weren’t doing theory all day long: you spoke to clients, you spoke to other people, you did some computer programming. It was very interesting and stimulating.

Financial physicists are sometimes blamed for the 2008 financial crisis – is that true? 
No. I don’t say they’re blameless, but nobody really knows what causes complicated crises. My basic feeling is that every time there’s been a crisis in the past 25 years, the US Federal Reserve has lowered interest rates to stimulate the economy. However, everyone wants to get a high yield from their investments, so for salespeople and financial companies it became very attractive to synthesize these supposedly high-yielding investments, such as mortgage-backed bonds. Except they turned out to be not so high-yielding. I think quants are to blame to the extent that they were part of the process for creating this kind of stuff, but I think they were a tool more than a cause: everybody wanted to get higher yield in a fed-induced low-yield environment and some quantitative models were used to try to do that.

Do you have any advice for students thinking of going into the financial industry? 
When I went in, it was like amateur heaven. You couldn’t have learned “financial engineering” even if you’d wanted to; you just came to work not knowing anything about finance, they put you on the job and you started to learn it. Now it’s a much more bureaucratic, organized system, so the hurdles are higher to get in. I wouldn’t say “don’t do it”, because I don’t think there’s anything wrong with it, but people have got to look at their own personal interests and decide.

What part of your physics training has been most valuable to you? 
Doing research taught me that some projects just take a long time. You may make mistakes and you may go off on wrong paths, but you’ll come back and keep trying to hack at it. I also like the physics approach. Economics and finance has become very, very formal. I don’t teach like this, but many people teach economics as if it were Euclidean geometry, with axioms and theorems and lemmas; as if the world satisfied all of those theorems, which it doesn’t. I think physicists have a very good idea of the right amount of rigour for the problem that they’re tackling. They understand the difference between an approximation and an idealization.