The efficient market model states all security prices today reflect all available information and only new information is going to change the price.
People tried for centuries to predict where asset prices would go, whether it was wheat or gold and eventually the stock market. And eventually, sometime around the ‘60s, academics began to realize that you really couldn’t say what was going to happen tomorrow and that you had, most of the time, no better facility than just chance in saying whether a stock price would go up or down tomorrow.
Mathematics is a way of formulating an idea, not an idea itself.
I think having a background as a physicist is kind of fortuitously good for people who work on Wall Street because there are a lot of fields that use mathematics, but physics is sort of the field par excellence. It has made the best use of mathematics. And I think physicists understand what’s a really good theory and what’s accurate and they also, in their every day life, work on models which are like approximations that give you some idea of the way something behaves. And they have a good sense for what’s a good theory and what’s a good model and where the boundary lies between them.
EMANUEL DERMAN is Head of Risk at Prisma Capital Partners and a professor at Columbia University, where he directs their program in financial engineering. He is the author of My Life As A Quant, one of Business Week's top ten books of the year, in which he introduced the quant world to a wide audience.
He was born in South Africa but has lived most of his professional life in Manhattan in New York City, where he has made contributions to several fields. He started out as a theoretical physicist, doing research on unified theories of elementary particle interactions. At AT&T Bell Laboratories in the 1980s he developed programming languages for business modeling. From 1985 to 2002 he worked on Wall Street, running quantitative strategies research groups in fixed income, equities and risk management, and was appointed a managing director at Goldman Sachs & Co. in 1997. The financial models he developed there, the Black-Derman-Toy interest rate model and the Derman-Kani local volatility model, have become widely used industry standards.
In his 1996 article Model Risk Derman pointed out the dangers that inevitably accompany the use of models, a theme he developed in My Life as a Quant. Among his many awards and honors, he was named the SunGard/IAFE Financial Engineer of the Year in 2000. He has a PhD in theoretical physics from Columbia University and is the author of numerous articles in elementary particle physics, computer science, and finance.