Thursday, August 31, 2006

Erice is beautiful

Having a wonderful time here. The mediterranean climate and light are as wonderful as I remember from many years ago.

Susskind and Douglas have been giving nice lectures on the string theory landscape. Lenny's attitude seems very reasonable. He said very clearly that string theory might be wrong, but that we could still learn from it. Personally I don't find it at all implausible that there are many universes with different physical laws and that ours is exceptional for anthropic reasons. (The earth is obviously an exceptional planet, for anthropic reasons!) However, I do think that it will be an unsatisfying end for science if the fundamental parameters are randomly determined with slight bias to accommodate life. One thing I have heard people say repeatedly here, something I've thought since I was a grad student, is that the standard model is itself an ugly Rube Goldberg contraption. Granted, it is tremendously successful in describing nature, but who ordered all of those extra generations and crazy fermion masses?

I had an interesting chat with 'tHooft about black holes and his belief that there is a deterministic structure underlying quantum mechanics. He admitted the Bell inequalities are a big problem for him and that so far he has been unable to formulate even any toy models he finds acceptable. Nevertheless he is quite sure of his viewpoint. Some of the descriptions he gave of his proto-theory seem to contain non-locality and other weirdness, but it's clear he's thought a lot about these issues. He predicted a limit to the capabilities of quantum computers as a result of his underlying description.

R.D. Kenway gave some nice lectures on the current state of lattice QCD. Very impressive recent progress on a number of fronts, ranging from chiral fermions to studies of topological charge to computation of electroweak matrix elements.

Physics is like a cloud. Looking directly at it the changes are almost imperceptible. But look away for a while, and you'll see everything has changed.

Some of the lectures are online here.

PS The main internet router broke today, so we were offline for about 12 hours while they obtained and installed a new one. Some were going nuts, but I noticed attention was more focused during the lectures. After the fancy banquet people (including me) were running back to the main building when they heard the network was back up :-)

Monday, August 28, 2006

Spacetime topology change and black hole information

I'm in Erice right now, so posting may (or may not) be interrupted depending on how exciting the talks are :-)


Spacetime topology change and black hole information

Abstract: Topology change --- the creation of a disconnected baby universe --- due to black hole collapse may resolve the information loss paradox. Evolution from an early time Cauchy surface to a final surface which includes a slice of the disconnected region can be unitary and consistent with conventional quantum mechanics. We discuss the issue of cluster decomposition, showing that any violations thereof are likely to be unobservably small. Topology change is similar to the black hole remnant scenario and only requires assumptions about the behavior of quantum gravity in planckian regimes. It does not require non-locality or any modification of low-energy physics.

I don't necessarily want to claim that topology change is plausible. But, it does suggest that we can't make progress on the black hole information problem by low-energy means alone, since there are possible solutions that have unobservable low-energy effects and depend on how quantum gravity behaves at planck densities.

I got some email already pointing me to the following interesting papers on this issue. The first two are by Ted Jacobson and the last by Easson and Brandenberger. All discuss, in one way or another, the possibility that things which fall into black holes end up "somewhere else" and the relation to the information loss paradox.


More. Early work by Mukhanov and Frolov on connecting deSitter space to the black hole interior (they assume strong planckian dynamics leads to a symmetrical equation of state with stress tensor proportional to g_mn, so deSitter is natural): (too old for arXiv).

There are also apparently many loop QG papers suggesting a repulsive equation of state at planck density, which is what is needed to have expansion instead of a singularity. I haven't tracked those papers down, but will add them here and to the revision of the paper. Also, Lee Smolin long ago proposed that black hole collapse might lead to new universe creation, although I believe that was part of a cosmological selection proposal and not to solve the information loss problem.

Interestingly, there seem to be two camps on this issue. People from a string theory background seem convinced that only the two traditional solutions are viable: locality violation and quantum xeroxing at the semiclassical horizon (possibly due to stringy effects and bh complementarity), or remnants. In the relativist community it seems people find the topology change option rather obvious and wonder why I wasn't aware of these earlier references. I'd like to put the two sides in a seminar room somewhere to mix it up! :-)

I came to this from the stringy side -- the review articles I cite are by Strominger, Banks, Giddings and Susskind, so I thought arguing the feasibility of the topology change scenario to be an uphill fight. The very first thing I do in the paper is present the two main objections to the idea. The first objection, that pure to mixed evolution (even at an effective level) must entail energy non-conservation, seems to have been discussed before by relativists (e.g., Wald). But the second objection, regarding cluster decomposition violation (multiple baby universe creation amplitudes don't factorize even when the black hole collapses are widely separated) does not seem to have been widely discussed.

Sunday, August 27, 2006

More Shiller

Get ready for more Robert Shiller, the Yale economist who called the tech bubble, coining the Greenspan-adopted term "irrational exuberance" along the way. Shiller has been doing some nice work on historical real estate prices, finding inflation-adjusted appreciation to be quite modest over the last century. This is violently against the conventional wisdom, but then what does the madding crowd know about calculating real returns?

See this Times piece on the latest prognostication about how our housing bubble is going to end.

Earlier related posts here and here. The second link has a nice figure comparing our bubble to the Japan real estate bubble of the 80's. You can see we could easily give back half the recent gains over, say, the next 10 years.

Friday, August 25, 2006


The graph below may soon be infamous. Thanks to a correspondent with access to expensive analyst newsletters :-)

In case you can't read the caption, it shows the NAHB (National Association of Home Builders) Housing Index vs. the S&P lagged by 12 months.

If you trade on this information, please send a portion of proceeds to me. Note, though, that past performance is no guarantee of future returns :-)

Wednesday, August 23, 2006


The New Yorker has a nice article on Perelman, his proof of the geometrization and Poincare conjectures, the politics surrounding the proof, and S.T. Yau's antics. If the article is correct (see end of excerpts below), Yau's maneuvering is directly related to Perelman's declining the Fields medal. Note he has not said whether he would decline the $1 million Clay Foundation prize ;-)

One of the authors is Sylvia Nasar, who wrote A Beautiful Mind. The writers actually went to St. Petersberg to track down the elusive genius, and have reconstructed the history behind his decade of work to produce the proof.

...In 1982, the year that Shing-Tung Yau won a Fields Medal, Perelman earned a perfect score and the gold medal at the International Mathematical Olympiad, in Budapest.

...In 1993, he began a two-year fellowship at Berkeley. While he was there, Hamilton gave several talks on campus, and in one he mentioned that he was working on the Poincaré. Hamilton’s Ricci-flow strategy was extremely technical and tricky to execute. After one of his talks at Berkeley, he told Perelman about his biggest obstacle. As a space is smoothed under the Ricci flow, some regions deform into what mathematicians refer to as “singularities.” Some regions, called “necks,” become attenuated areas of infinite density. More troubling to Hamilton was a kind of singularity he called the “cigar.” If cigars formed, Hamilton worried, it might be impossible to achieve uniform geometry. Perelman realized that a paper he had written on Alexandrov spaces might help Hamilton prove Thurston’s conjecture—and the Poincaré—once Hamilton solved the cigar problem. “At some point, I asked Hamilton if he knew a certain collapsing result that I had proved but not published—which turned out to be very useful,” Perelman said. “Later, I realized that he didn’t understand what I was talking about.” Dan Stroock, of M.I.T., said, “Perelman may have learned stuff from Yau and Hamilton, but, at the time, they were not learning from him.”

By the end of his first year at Berkeley, Perelman had written several strikingly original papers. He was asked to give a lecture at the 1994 I.M.U. congress, in Zurich, and invited to apply for jobs at Stanford, Princeton, the Institute for Advanced Study, and the University of Tel Aviv. Like Yau, Perelman was a formidable problem solver. Instead of spending years constructing an intricate theoretical framework, or defining new areas of research, he focussed on obtaining particular results. According to Mikhail Gromov, a renowned Russian geometer who has collaborated with Perelman, he had been trying to overcome a technical difficulty relating to Alexandrov spaces and had apparently been stumped. “He couldn’t do it,” Gromov said. “It was hopeless.”

Perelman told us that he liked to work on several problems at once. At Berkeley, however, he found himself returning again and again to Hamilton’s Ricci-flow equation and the problem that Hamilton thought he could solve with it. Some of Perelman’s friends noticed that he was becoming more and more ascetic. Visitors from St. Petersburg who stayed in his apartment were struck by how sparsely furnished it was. Others worried that he seemed to want to reduce life to a set of rigid axioms. When a member of a hiring committee at Stanford asked him for a C.V. to include with requests for letters of recommendation, Perelman balked. “If they know my work, they don’t need my C.V.,” he said. “If they need my C.V., they don’t know my work.”

...Perelman had posted a thirty-nine-page paper entitled “The Entropy Formula for the Ricci Flow and Its Geometric Applications,” on, a Web site used by mathematicians to post preprints—articles awaiting publication in refereed journals. He then e-mailed an abstract of his paper to a dozen mathematicians in the United States—including Hamilton, Tian, and Yau—none of whom had heard from him for years. In the abstract, he explained that he had written “a sketch of an eclectic proof” of the geometrization conjecture.

Perelman had not mentioned the proof or shown it to anyone. “I didn’t have any friends with whom I could discuss this,” he said in St. Petersburg. “I didn’t want to discuss my work with someone I didn’t trust.” Andrew Wiles had also kept the fact that he was working on Fermat’s last theorem a secret, but he had had a colleague vet the proof before making it public. Perelman, by casually posting a proof on the Internet of one of the most famous problems in mathematics, was not just flouting academic convention but taking a considerable risk. If the proof was flawed, he would be publicly humiliated, and there would be no way to prevent another mathematician from fixing any errors and claiming victory. But Perelman said he was not particularly concerned. “My reasoning was: if I made an error and someone used my work to construct a correct proof I would be pleased,” he said. “I never set out to be the sole solver of the Poincaré.”

Gang Tian was in his office at M.I.T. when he received Perelman’s e-mail. He and Perelman had been friendly in 1992, when they were both at N.Y.U. and had attended the same weekly math seminar in Princeton. “I immediately realized its importance,” Tian said of Perelman’s paper. Tian began to read the paper and discuss it with colleagues, who were equally enthusiastic.

On November 19th, Vitali Kapovitch, a geometer, sent Perelman an e-mail:

Hi Grisha, Sorry to bother you but a lot of people are asking me about your preprint “The entropy formula for the Ricci . . .” Do I understand it correctly that while you cannot yet do all the steps in the Hamilton program you can do enough so that using some collapsing results you can prove geometrization? Vitali.

Perelman’s response, the next day, was terse: “That’s correct. Grisha.”

...Perelman repeatedly said that he had retired from the mathematics community and no longer considered himself a professional mathematician. ... “It is not people who break ethical standards who are regarded as aliens,” he said. “It is people like me who are isolated.” We asked him whether he had read Cao and Zhu’s paper. “It is not clear to me what new contribution did they make,” he said. “Apparently, Zhu did not quite understand the argument and reworked it.” As for Yau, Perelman said, “I can’t say I’m outraged. Other people do worse. Of course, there are many mathematicians who are more or less honest. But almost all of them are conformists. They are more or less honest, but they tolerate those who are not honest.”

The prospect of being awarded a Fields Medal had forced him to make a complete break with his profession. “As long as I was not conspicuous, I had a choice,” Perelman explained. “Either to make some ugly thing”—a fuss about the math community’s lack of integrity—“or, if I didn’t do this kind of thing, to be treated as a pet. Now, when I become a very conspicuous person, I cannot stay a pet and say nothing. That is why I had to quit.” We asked Perelman whether, by refusing the Fields and withdrawing from his profession, he was eliminating any possibility of influencing the discipline. “I am not a politician!” he replied, angrily. Perelman would not say whether his objection to awards extended to the Clay Institute’s million-dollar prize. “I’m not going to decide whether to accept the prize until it is offered,” he said.

Mikhail Gromov, the Russian geometer, said that he understood Perelman’s logic: “To do great work, you have to have a pure mind. You can think only about the mathematics. Everything else is human weakness. Accepting prizes is showing weakness.” Others might view Perelman’s refusal to accept a Fields as arrogant, Gromov said, but his principles are admirable. “The ideal scientist does science and cares about nothing else,” he said. “He wants to live this ideal. Now, I don’t think he really lives on this ideal plane. But he wants to.”


Bubbles last longer than you expect, and deflate faster than you expect. Has the US housing bubble finally popped? Will it be a hard, soft or hard-soft landing? The Fed is clearly convinced the housing slowdown is well underway, and that it will reduce inflation and economic growth.

The WSJ reports today on some of the associated mayhem. It's anecdotal journalism, but backed up by statistical data as well.

PIMCO's Bill Gross has been betting on a slowdown for some time -- and taking the pain while waiting. This article describes how hard trading can be, even for a superstar like Gross. Another interesting tidbit is that PIMCO actually sends out researchers posing as house buyers to test markets around the country.

Excerpts from both articles below.

"It would be difficult to characterize the position of home builders as other than in a hard landing," says Robert Toll, chief executive of luxury home builder Toll Brothers Inc., which reported yesterday that net income fell 19% in the third quarter ended July 31. (See related article.)

In his 40 years as a home builder, Mr. Toll says, he has never seen a slump unfold like the current one. "I've never seen a downturn in housing without a downturn in employment or... some macroeconomic nasty condition that took housing down along with other elements of the economy," he says. "This time, you've got low unemployment, you've got job creation, you've got a stable stock market and relatively low interest rates."

Joan Guth is one homeowner who was taken by surprise. Last September, she put her stately five-bedroom home in Herndon, Va., on the market for about $1.1 million. She was confident she would get something near that price, and planned to use the proceeds to buy a retirement home in Florida. But her home in the Washington suburbs attracted few serious lookers, and in March, she cut her asking price to $899,900. Still there were no takers. Finally, on the advice of her broker, she called in an auction firm, beginning a process that would eventually reveal to her just how weak the Northern Virginia market had become. [Eventually, she gets only $500k!]

...In a speech yesterday, Michael Moskow, president of the Federal Reserve Bank of Chicago, noted: "While we factor a housing slowdown into our outlook, there is some evidence -- such as higher rates of cancellation in home-building contracts -- that the slowdown could be more extensive."

With fewer consumers applying for home loans, some big mortgage lenders are already retrenching. Countrywide Financial Corp. last month announced plans to reduce costs by $500 million. Earlier this year, Washington Mutual Inc. eliminated 2,500 jobs at loan-processing centers.

Builders, who were optimistic about prospects until a few months ago, are cutting back too. KB Home, a big home builder based in Los Angeles, has eliminated 7% of its work force, or 440 jobs. In July, U.S. home builders started construction at an annual rate of 1.45 million single-family homes, down 20% from the January peak.

Last August, when Horsham, Pa.-based Toll Brothers reported that its quarterly profit had doubled, Mr. Toll boasted: "We've got the supply, and the market has got the demand. So it's a match made in heaven." Since then, Toll has cuts its guidance four times on the number of homes it expects to close on, and its share price has fallen by more than 45%. Yesterday, the company said orders for new homes in the third quarter were down 48% from a year earlier.

...At D.R. Horton Inc., the nation's largest home builder by units built per year, executives said late last year they were confident that quarterly earnings would continue to increase even during a housing-market slump. In July, Horton reported a 21% decline in net income for the third quarter ended June 30, the first quarter in 28 years in which it didn't report year-over-year profit growth. Horton's chief executive, Donald Tomnitz, said the surge in home prices had priced many people out of the market.

"Every time we've gone into a downturn in the home-building industry, they've always been longer and deeper than we've all imagined," Mr. Tomnitz told analysts in a July 20 conference call. "So we're preparing for the worst, and we think this one will be longer and deeper than just the last six months."

Bill Gross is Wall Street's long-reigning bond king, but he is struggling to adapt to a new world.

For more than three decades, Mr. Gross, the 62-year-old chief investment officer at Pacific Investment Management Co., which has $617 billion in assets, has run the world's largest bond mutual fund. In that time, the $95 billion Pimco Total Return Fund has handily outpaced both the bond market and almost all of its competitors. In 2000, when Germany's Allianz AG bought Pimco, based in Newport Beach, Calif., it was so eager to keep Mr. Gross at the helm that it agreed to a pay package valued at about $200 million to keep him around through next year.

As hedge funds and other investors have been scooping up riskier bonds with the highest yields, however, it has been harder for Mr. Gross to beat the market by buying this kind of debt.

...At the same time, Mr. Gross has taken a contrarian view for many months, predicting a slowdown for the economy and an end to the Federal Reserve's campaign to raise interest rates. For much of the year that stance didn't work. The losses, and the added volatility, took a toll on Mr. Gross, a soft-spoken manager who usually keeps an even keel by practicing yoga.

A month ago, with Pimco's bets misfiring, Mr. Gross was so stressed that he left the office, taking an unplanned vacation, sitting at his home with his wife, he says.

"I just had to leave for nine days, I couldn't turn on business television, I couldn't pick up the paper, it was just devastating," Mr. Gross says in an interview at Pimco's headquarters, near the Pacific Ocean. "We've increased the volatility [of the portfolio] but I'm not enjoying it. You can't sleep at night."

...Now, his predictions that the housing market would slump and the economy would suffer are starting to show signs of materializing, sending the bond market on an impressive rally that has sent the benchmark 10-year yield -- which moves in the opposite direction of its price -- down to 4.817% yesterday from 5.25%, since June 28.

...Mr. Gross remains bullish on bonds, which tend to do well in a slowing economy, in part because weakness in the housing market will discourage the Fed from raising short-term interest rates -- and could even get them to cut rates in the year ahead, he says. Mr. Gross collects reams of data on the housing market and reads it at home on the weekends, and Pimco even sends "shoppers" to key markets across the country to pose as home buyers and pick up intelligence on where housing is going.

Part of his concern stems from the aggressive adjustable-rate mortgages he has seen many consumers -- including two of his children -- take on. He isn't sure they will be able to handle the monthly payments when the interest rates on these mortgages adjust higher.

"We could really see a drop in home prices that hurts the economy," he says.

Monday, August 21, 2006

On the volatility of volatility

More than you might want to know about volatility of the S&P500 index in this research article I've written with my PhD student Brian Murray. Brian has completed his dissertation work here (four research articles on dark energy, instabilities, black holes, etc.) and has decided he wants to pursue a career as a quant. Anyone interested in hiring a sharp young problem solver, please let me know. Previous posts on volatility.

My favorite footnote from the article:
"Implied volatility which is systematically larger than realized volatility would seem to provide a risk-free arbitrage, since it means all options contracts are overpriced. In an idealized world of log-normal price fluctuations, a trader could sell options contracts and hedge away the risk by holding cash and the underlying. However, in the real world, where volatility is itself volatile, there is no foolproof way to completely hedge away the risk of selling an option. An option seller is paid a premium to bear this risk, namely the systematic difference between implied and realized volatilities."

Title: On the volatility of volatility

Abstract: The Chicago Board Options Exchange (CBOE) Volatility Index, VIX, is calculated based on prices of out-of-the-money put and call options on the S&P 500 index (SPX). Sometimes called the "investor fear gauge,'' the VIX is a measure of the implied volatility of the SPX, and is observed to be correlated with the 30-day realized volatility of the SPX. Changes in the VIX are observed to be negatively correlated with changes in the SPX. However, no significant correlation between changes in the VIX and changes in the 30-day realized volatility of the SPX are observed. We investigate whether this indicates a mispricing of options following large VIX moves, and examine the relation to excess returns from variance swaps.

Sunday, August 20, 2006

Invisible Asians

Asian-Americans are invisible. We're not a minority group. At least not to the politically correct intellectual contortionists at the NYTimes. Insidious racism, rather than meritocratic testing, must be responsible for the alarming decline in the representation of (certain) ethnic groups in NYC's top high schools.

See earlier posts on how affirmative action hurts Asian-Americans (Asians have to score 50 points higher, on average, on the SAT than whites to gain admission to the same elite universities), and how the silicon valley counterpart to this NYC magnet school story is told in a less politically correct way by the WSJ.


The New York Times headline is: Minority Students Decline in Top New York Schools. The graphic? Here:

Is something off with this graphic in relation to the headline, or what? Ah, click the link in the story, and you see this:

Saturday, August 19, 2006

Universities as economic engines?

The Times article excerpted below quotes studies questioning the value of investing in universities as engines of economic growth. It seems obvious to me that proximity to universities with strong technical (science and engineering) departments is a necessary, but not sufficient, criteria for having a vibrant high tech economy. Certainly every high tech mecca (bay area, southern California, Boston, Seattle, Austin -- in rough order of VC investment per annum) is near one or more top universities.

But, there are many other factors that produce the silicon valley network effect, in particular access to venture capital, experienced financiers, entrepreneurs and engineers, and proximity to mature (public) technology companies. With so many factors at play, finding a statistical correlation with a single factor such as the quality of the local university is challenging.

NYTimes: ...If Stanford can hatch world-famous companies around Palo Alto, politicians assume, their colleges can, too. But with so many trying to spin universities away from their traditional academic focus into engines of economic development, it is worth considering whether investing in local universities can achieve that goal.

This strategy is based on the view that research done by professors can form the basis for local start-up companies and that the graduates of the university can supply the entrepreneurs and employees.

But advocates should remember an old maxim of economic development: Beware of investing in things that can move. As it turns out, graduates and research ideas both tend to move around a lot.

Subsidizing teaching is problematic as a development strategy because graduates frequently move out of state.

A study by the economists John Bound, Jeffrey Groen and Gabor Kezdi of the University of Michigan and Sarah Turner of the University of Virginia, “Trade in University Training: Cross-State Variation in the Production and Stock of College-Educated Labor,” ( found little evidence of people staying in places because they went to college there.

The more likely smart people are to leave, the more money their state is spending on helping another area’s economy develop. Marc Andreessen, for example, invented the Web browser while at the University of Illinois, but then founded Netscape in the actual Silicon Valley rather than starting a new one in Urbana.

Texas may subsidize science teaching at the University of Texas, El Paso, but the chance that its graduates will stay and transform the local area into Silicon Rio Grande is remote.

So if a state’s subsidies to graduates from a university will not create new Silicon Valleys, how about subsidizing the research? There is no question that academic research has hatched many of today’s booming technology industries. But scientific and engineering ideas also travel quickly.

Recall the 1980’s, when Japanese companies rose to prominence by producing things that had been invented in the United States, like photocopiers, computer memory chips and video recorders.

In a recent study of the determinants of the creation of high-tech firms in different locations, “Movement of Star Scientists and Engineers and High-Tech Firm Entry” (, Professors Lynne G. Zucker and Michael R. Darby of the University of California, Los Angeles, examined the importance of what they called “disembodied discoveries.”

They looked at such factors as having successful patents at universities or where highly influential science articles had originated. They found little evidence that the ideas helped local businesses any more than businesses in other areas.

For every Stanford in Silicon Valley, there seem to be several Purdues in West Lafayette, Ind., or Cornells of Ithaca, N.Y. — places filled with path-breaking discoveries but with local economies that are seldom seen as the next Silicon Valley.

The one thing the study does find to be consistently associated with high-tech start-ups is the presence of star scientists — not the ideas, which can be copied, but the scientists themselves. This seems to be the one way in which a university can be used as an engine of business growth.

Wednesday, August 16, 2006

Portrait of a quant II

Those funsters at Businessweek have another goofy bit about quants in their latest issue. (See their previous article Math Rules! and here for previous quant-related posts.)

Well, they have the general idea right. If you can't read the text in the figure below, it says " from MIT, Caltech or India in applied mathematics, physics, computer science or all of the above", "800 math SAT de rigueur" and "math tournament rock star" :-)

The Quintessential Quant: James H. Simons, the former math professor who founded the $12 billion quantitative shop Renaissance Technologies Corp., pocketed an estimated $1.5 billion last year. That was thanks to the 5% in fees and nearly 44% of profits that Renaissance docks its investors (vs. traditional hedge funds' typical "2 and 20"). Clients don't complain; Renaissance's leading fund has returned 35%, after fees, since 1989. And D.E. Shaw & Corp., the brainchild of ex-Columbia University computer science professor David E. Shaw, with $23 billion in capital, has netted investors 21% a year for 17 years, without a single losing 12-month stretch.

Landing a job at either of these shops can be insanely lucrative -- and even more insanely competitive. "Using a self-consciously obnoxious term, we're looking for superstars, the kinds of people who would be extraordinarily good at nearly anything," says Nicholas P. Gianakouros, head of global recruiting for New York-based D.E. Shaw.

He is being euphemistic. The handful of quant and programming geniuses who get into the toughest mathematics, physics, and computer science PhD programs on the planet are already best in class. So screening for the 5 or ten very best of that best means establishing a whole new set of prerequisites. "The quant shops are a different animal," says Alison Seanor, vice-president at Glocap Search, a Manhattan hedge-fund recruiter. What is the "it" factor that distinguishes the crème de la crème? All Seanor will say is, "I know it when I see it."

One obvious filter is that liberal arts students -- or even bankers and stock jockeys -- need not apply. What you will need is a nosebleed grade-point average in applied mathematics, physics, or computer science at an elite school like the Massachusetts Institute of Technology, California Institute of Technology, or Indian Institutes of Technology. Many of these students are published and have won high math honors such as the Putnam Fellowship. Often, their names are already so well known in the field that the quant funds make the first approach.

Another must-have: an 800 math SAT score (even if you sat for that exam in your awkward adolescence). Although the funds diplomatically claim the number is "just another data point," it's pretty well understood to be a critical credential.

The quant shops want malleable intellect untainted by Wall Street dogma -- i.e., not "buy, sell, or hold" types. "They're not really looking to make money on corporate events like takeovers," says Emanuel Derman, director of the financial engineering program at Columbia University and head of risk for quant house Prisma Capital Markets. "They're looking to make money on mathematical models." Top funds often advertise in esoteric scientific journals. "You'll not likely find our ads in a dentist's waiting room," says D.E. Shaw's Gianakouros.

If yours is one of the lucky 1% to 3% of résumés to survive an exhaustive initial culling, you can look forward to an hour-long phone interview peppered with thought problems and brain teasers. Pass that test and you will then be summoned as many as three times to undergo up to a dozen grueling interviews. "Every interviewer uses a different approach," says Gianakouros, citing programming problems and math proofs. Expect to be asked to build an intricate Excel model on the spot. Whatever the case, advises Derman, "don't say anything unless you're ready to be quizzed on it."

The firm will then solicit references for areas in which a candidate may appear weak. Ultimately, it takes a consensus among everyone who has met the candidate to extend a coveted offer. D.E. Shaw says that out of every 500 candidates who got the initial callback, only one makes the final cut. Many agree it's even harder to get into secretive Renaissance, which would not comment for this story.

A typical offer, say sources, starts with a base salary of around $250,000, plus a guaranteed annual bonus that could double that. The best can command a cut of a fund's upside -- beaucoup bucks when you consider the multibillion-dollar asset pots. All this, yet, says Seanor, "most of these guys have never even had a real job."

Tuesday, August 15, 2006

MIT vs Caltech: Nobel count

[ 2015: Updated information. ]

I learned from the Caltech News alumni magazine that 17 Caltech alumni have won the Nobel prize, versus 25 from MIT. You might think the advantage here goes to MIT, but their student body is 5 times larger! Most people are shocked to learn that Caltech's graduating class is only about 200 students. On a per-capita basis, I believe Caltech produces more science Nobel prizes than any other school. Keep in mind that about half of Caltech undergrads major in engineering or computer science, which are not Nobel-eligible disciplines.

When I was a student we used to joke that MIT stood for "Many Incompetent Technologists" (emphasis on Many) or "Made In Taiwan" :-)

On the other hand, Feynman went there, so it can't be all bad. Actually I have to admit it is probably more fun to be an undergrad at MIT than at Caltech (part of it is that the classes are so much easier :-). When I lived in Cambridge I could see there was a much more lively college scene in Boston than LA. MIT is bigger and has a better male-female ratio and more balanced social life than Caltech. Of course, the climate in Boston isn't as nice.

Before I had twins and startups I used to be involved in Caltech admissions and recruiting -- including calling up admitted students to answer questions and give advice. I was often speaking to students who had been admitted to both Caltech and MIT, and I was always scrupulously fair in describing the pros and cons of the two places.

More Caltech bragging: patents and PhDs.

Saturday, August 12, 2006

Put/call ratio and stat arb

It looks like put/call volume ratios (suitably cleaned, subtracting market makers, etc.) have predictive value for the underlying stock. A model portfolio going short/long the 20% of names with the highest/lowest ratios would have made 60% annualized returns over the last dozen years, with no down years (trading costs might reduce this to 50%). A subscription to the CBOE data necessary for this analysis is now available for a $600/month fee. I wonder what the weekly or monthly Sharpe ratio is for this strategy?

More good evidence against the strong efficient market hypothesis :-)

NYTimes: A new study has found that a portfolio based on the preferences of options traders has consistently beaten the overall stock market. In reaching that conclusion, the study paves the way for what may be a very profitable stock-picking strategy.

The study, “The Information in Option Volume for Future Stock Prices,” appears in the fall 2006 issue of the Review of Financial Studies. Its authors are two associate professors of finance: Jun Pan of the Sloan School of Management at the Massachusetts Institute of Technology and Allen M. Poteshman of the University of Illinois at Urbana-Champaign.

...Until now, there has been no comprehensive study of option traders’ track records as stock pickers. That hasn’t been for want of trying: the requisite data simply was not available to researchers. The volume figures that options exchanges report publicly, for example, reflect a combination of several kinds of transactions, muddying the overall picture. The volume number reported for a given option, for example, may reflect new purchases by options traders, but it may also include the sale of positions previously acquired. That makes it hard to tell whether traders actually favored a stock.

Using a private database provided by the Chicago Board Options Exchange, the two professors were able to deconstruct an option’s total trading volume into various categories. They excluded trades by market makers, for example — dealers at the options exchange who buy and sell securities for the general purpose of maintaining liquidity. They narrowed the database further to focus on just that portion of an option’s daily trading volume that reflected new positions by other traders, on the assumption that these transactions offered a clearer signal of what traders actually thought of the underlying stock. The database covered the dozen years from the beginning of 1990 through the end of 2001.

For each option in this database, the professors calculated a daily volume ratio of newly acquired put options to newly acquired call options. A high ratio meant a strong consensus among options traders that the price of the option’s underlying stock would fall, while a low ratio showed a widely shared expectation that the stock would rise. The professors found that the stocks whose options had the lowest ratios consistently outperformed the stocks whose options had the highest ratios.

Consider this hypothetical portfolio constructed by the professors: it held the stocks of the 20 percent of options with the lowest put-call ratios, while selling short the stocks whose options had the highest such ratios. (The portfolio was readjusted weekly, adding and deleting stocks because of changes in the ratios.)

The professors reported that before transaction costs, this portfolio produced an annual average return of 62 percent over the dozen years covered in the study. This contrasts with an annualized total return of 12.3 percent for the general stock market over this period, as measured by the Dow Jones Wilshire 5000 index. Still more impressive was the fact that the portfolio earned double-digit returns each year, even when the overall market declined. Based on their data, however, the professors had no way to determine how options traders were able to achieve these results.

The portfolio required frequent transactions because the price moves correctly anticipated by options traders lasted for only a couple of weeks, on average. So transaction costs would have eaten up a big chunk of the return. But Professor Poteshman estimated that in the hands of an institutional investor, for whom such costs would typically be quite low, the portfolio’s return would still have been as much as 50 percent annually.

Even for individual investors, who would pay higher costs, Professor Poteshman estimated that the annualized return would have been well into double digits.

DESPITE the strong results of the strategy, it would have no more than academic interest if investors had no access to the private C.B.O.E. database that the professors studied. In July, however, the exchange began selling subscriptions to this database to the public.

A subscription isn’t cheap: $600 a month. That helps make the professors’ strategy impractical for small investors. Still, the study shows that potentially valuable information can be found in options traders’ behavior. And institutional investors, including hedge funds and mutual funds, can easily exploit it.

Wednesday, August 09, 2006

Theorist vies for poker title

Former(?) particle theorist Michael Binger (PhD Stanford, perturbative QCD) is among the finalists at the 37th World Series of Poker in Las Vegas. Last I checked, Binger had over $3 million in chips, but is only in 8th place.

Binger says he got "burned out" on physics around 2002 and has been earning his living at poker ever since. He "hopes to continue doing research in physics without having to run the rat-race of getting a job and impressing all the right people as he puts it." Sounds like a familiar dream :-)

Binger and other poker gods might someday go the way of Kasparov -- replaced by machines.

(Via Dave Bacon.)

Update: Binger took 3rd place and won $4M. The Times covered the wrong story -- they wrote about some hedge fund guy who placed 18th and donated his $650k to charity.

Tuesday, August 08, 2006

Economist on blogging professors

Buried in the article, which is mainly about blogging economists (and mentions a number our favorites, like the two Brads, but unfortunately not Mark Thoma of Economist's View), is the nugget below on how the gap between faculty quality (or at least productivity) at the very top schools and elsewhere has narrowed due to new technology.

Another factor, at least in theoretical physics, has been the terrible job market that persisted through the last 30 years of the 20th century (it seems to be better now, as sputnik era professors finally seem to be retiring). From around 1970-2000 there were only a handful of jobs per year in particle theory, and even average research universities were able to hire exceptional people. In many of those years, the new crop of PhDs from any one of the top programs could have filled every faculty opening in the country. A little arithmetic is enough to understand the consequent logjam, and why there are so many former theorists in finance, technology, even biology.

With professors spending so much time blogging for no payment, universities might wonder whether this detracts from their value. Although there is no evidence of a direct link between blogging and publishing productivity, a new study* by E. Han Kim and Adair Morse, of the University of Michigan, and Luigi Zingales, of the University of Chicago, shows that the internet's ability to spread knowledge beyond university classrooms has diminished the competitive edge that elite schools once held.

Top universities once benefited from having clusters of star professors. The study showed that during the 1970s, an economics professor from a random university, outside the top 25 programmes, would double his research productivity by moving to Harvard. The strong relationship between individual output and that of one's colleagues weakened in the 1980s, and vanished by the end of the 1990s.

The faster flow of information and the waning importance of location—which blogs exemplify—have made it easier for economists from any university to have access to the best brains in their field. That anyone with an internet connection can sit in on a virtual lecture from Mr DeLong means that his ideas move freely beyond the boundaries of Berkeley, creating a welfare gain for professors and the public.

Universities can also benefit in this part of the equation. Although communications technology may have made a dent in the productivity edge of elite schools, productivity is hardly the only measure of success for a university. Prominent professors with popular blogs are good publicity, and distance in academia is not dead: the best students will still seek proximity to the best minds. When a top university hires academics, it enhances the reputations of the professors, too. That is likely to make their blogs more popular.

Friday, August 04, 2006

A trillion dollar question

Brad Setser notes that China's dollar reserves will soon surpass the trillion mark, if they have not already. Where to invest all those dollars? OPEC nations, Russia and other Asian exporters (Korea, Taiwan, Japan) share the same problem.

Hedge fund quiz question #1: Is the yield curve flat because traders think the fed is likely to overtighten (leading to a recession in a year or two), or because of all those foreign central bank dollars looking for a parking spot?

By my count China already has over a trillion dollars in reserves and reserve-like assets. But I am counting the funds the PBoC shifted to the state banks. In a couple of months, though, China will formally announce that its reserves now top a trillion dollars. So it isn’t exactly a surprise that Chinese policy makers would be spending a bit of time thinking about how to use those funds.

The key fact for the global economy is not that China holds a trillion dollars in reserves. It is that those reserves are growing at a pace of around $20b a month/ $250b a year. This reserve increase has continued even as interest rate differentials have moved steadily in the dollar’s favor. China constantly struggles not just to invest its existing reserves productively, but to find new places to park its ever growing reserves.

Right now, there is no reason to think that China won’t have $1,500b in reserves in about two years time. Not unless Chinese policy makers show an ability to act far more decisively than they have so far.

$250b is a lot of money to invest every year. I suspect there are some constraints on how China can invest it. There aren’t many – strike that, there aren’t any – emerging markets that could absorb inflows on that scale. Modest sized industrial economies like Australia and the UK are also too small to absorb more than a small fraction of the total. Look at their respective current account deficits in dollar billions.

Japan’s government debt market is very, very big. But JGBs don’t pay much interest, and the PBoC likes a bit of carry. So China really is left looking at the US and the European market. I don’t really buy the notion that European debt markets are too small and illiquid for China. China likely has been placing funds in some smaller and less liquid debt markets in the US, not just the most liquid of instruments. But I do think that it would be hard for China to continue to peg to the dollar and dramatically increase its euro allocation.

Suppose China now invests 25% of its reserve growth in euros. That is $60b a year or so. Real money. Suppose it decided it wanted to invest 50% in euros. That is $125b a year. I suspect that a $60b increase in net flows to Europe would have an impact on the euro/ dollar exchange rate. And if it did, China’s peg implies that the RMB would depreciate along with the dollar. That would force China to buy more reserves.

Tuesday, August 01, 2006

Globalization: theory and an example

From Economist's View, excerpts from a recent paper by Harvard economist Richard Freeman on how globalization is affecting worldwide labor markets. Some key points: a doubling of the global labor pool in recent decades has changed the ratio of capital to labor significantly. The increase in available labor has a significant high-skill component, which will impact highly educated workers in the west, particularly in science and technology.

Following the Freeman excerpts, I quote from an article in today's WSJ, which discusses how rapidly China has moved up the manufacturing value chain. They will soon surpass Germany to become the number 3 producer of automobiles. Given that China produces several times more engineers per year than the US, working for a fraction of western salaries, it is no surprise to me (despite predictions from just a few years ago) that they can climb the value chain so quickly. The final claim, soon to be overturned, is that China can only copy, but not innovate.

Some earlier posts on China development here, here and here.

Freeman: At first, the advent of huge numbers of workers from India and China into the global capitalist system seemed to offer a boon to most workers in advanced countries. The labor force is less skilled in the global giants than in the advanced economies. According to the Heckscher-Ohlin model, skilled workers in the advanced countries would benefit from the new trading opportunities while only the relatively small number of unskilled workers would lose. If all workers in the North were sufficiently educated, they would avoid competing with low paid labor overseas and benefit from the low priced products produced there. Competition from low wage workers in China and India might create problems for apparel workers in Central and Latin America or for South Africa, but not for ... the advanced North. Similarly, the “North-South” trade model that analyzes how technology affects trade between advanced and developing countries implied that trade would benefit workers in the North, who had exclusive access to the most modern technology. More low wage workers in the developing world would lead to greater production of the goods in which the South specialized, driving down their prices.

Tell it to Lou Dobbs! The off shoring of computer jobs, the US’s trade deficits even in high technology sectors, and the global sourcing strategies of major firms have challenged this sanguine view. The advent of China, India, and the ex-Soviet Union shifted the global capital-labor ratio massively against workers. Expansion of higher education in developing countries has increased the supply of highly educated workers and allowed the emerging giants to compete with the advanced countries even in the leading edge sectors that the North-South model assigned to the North as its birthright.

...the global labor market changed greatly in the 1990s due to the advent of China, India, and the ex-Soviet bloc to the world economic system. During the Cold War era, these countries had trade barriers, self-contained capital markets, and little immigration to the advanced countries – all of which isolated their labor markets from those in the US and the rest of the capitalist global world. The collapse of Soviet communism, China’s decision to “marketize” its economy, and India’s rejection of autarky, greatly increased the supply of labor available to the global capitalist system. I estimate that if China, India, and the ex-Soviet bloc had remained outside of the global economy, there would be about 1.46 billion workers in the global economy in 2000 (figure 1). Because those countries joined the rest of the world, there were 2.93 billion workers in the global economy in 2000. Since twice 1.46 billion is 2.92 billion, I have called this “The Great Doubling”... The effect of this huge increase in the work force changed the balance between labor and capital in the global economy. ...

I estimate that as result of the doubling of the global work force the ratio of capital to labor in the world economy in 2000 fell to 61 percent of what it would have been in 2000 before China, India, and the ex-Soviet bloc joined the world economy. ... By giving firms a new supply of low wage labor, the doubling of the global work force has weakened the bargaining position of workers in the advanced countries and in many developing countries as well. Firms threaten to move facilities to lower wage settings or to import products made by low wage workers if their current work force does not accept lower wages or working conditions, to which there is no strong labor response. The result is a very different globalization than the IMF, World Bank, and other international trade and financial organizations envisaged two decades or so ago when they developed their policy recommendations for the world economy.

...Countries around the world, including the new giants, have invested heavily in higher education, so that the number of college and university students and graduates outside the US has grown rapidly relative to the number in the US. ...

But highly populous low wage countries have also invested heavily in higher education. Indonesia, Brazil, China, India – name the country – have more than doubled university student enrolments in the 1980s and 1990s (Freeman, 2006). China has made a particularly large investment in science and engineering, so that by 2010 it will graduate more PhDs in science and engineering than the US. While the quality of graduate training is higher in the US than in China, China will surely improve quality over time. India has produced many computer programmers and engineers. ...

Comparative advantage, comparative advantage, wherefore art thou, oh comparative advantage?

In the North-South model that trade economists use to analyze how technology affects trade between the advanced North and the developing South, the advanced countries monopolize cutting edge innovative sectors while developing countries end up producing traditional products. The greater the rate of technological advance and the slower the spread of the newest technology to low wage countries, the higher paid are workers in the North relative to workers in the South. The comparative advantage of advanced countries in high tech sectors is rooted in those countries having more scientists and engineers and other highly educated workers relative to the overall work force than developing countries.

In these sorts of analyses, the spread of higher education and modern technology to low wage countries can reduce advanced countries’ comparative advantage in high-tech sectors and adversely affect workers in the advanced countries as a result. Any country with a comparative advantage in a given sector can lose when another country can compete successfully in that sector. ... If a foreign competitor gains comparative advantage in industries that have particularly desirable attributes– that employ large numbers of highly educated workers and offer great opportunities for rapid technological advance – the country with the initial advantage has to shift resources to less desirable sectors – those with lower chance for productivity growth, with fewer good jobs, and so on. The usual assumption regarding high tech sectors is that only advanced countries have the educated work force necessary for competing in them. In the 1980s, Americans got worked up when Japan seemed to be producing better high tech products than the US.
In the 1990s the US worried about the competition between Airbus and Boeing in the manufacturing of aircraft. No one entertained the notion that China or India would become major players in high technology leading edge industries. ...

The advance of China and India into high tech has obsolesced these analyses. China has moved rapidly up the technological ladder; has greatly increased its high tech exports, and has achieved a significant position in research in what is purported to be the next big industrial technology – nanotechnology. Over 750 multinational firms have set up R&D facilities in China. China’s share of scientific research papers has risen greatly. While India has not invested as much in science and engineering as China, it has achieved a strong international position in information technology, also attracting major R&D investments, particularly in Bangalore. How can low income countries with few scientists and engineers relative to their work forces compete in high tech?

These countries have moved to the technological frontier because success in high tech depends on the absolute number of scientists and engineers rather than on the relative number of S&E workers to the work force. It isn’t how many engineers per person that produces a technological breakthrough as much as the total number of engineers working on the problem. ...

I have called the process of moving up the technological ladder by educating large numbers as “human resource leapfrogging” since it uses human resources to leapfrog comparative advantage from low tech to high tech sectors, contrary to the assumption of the North-South model. The low wages in these large populous countries, moreover, makes them formidable competitors for an advanced country because it gives them a potentially large cost advantage in attracting R&D. ...

In sum, the notion that US skilled workers need not worry about competition from equally skilled workers in low income countries because developing countries have fewer graduates per capita does not fit with reality. With an increased supply of highly educated persons from low wage developing countries, multinational firms can offshore high-skilled work and hire graduates from universities world wide; while large numbers of highly educated immigrants can come to the US to work.

WSJ: Raising the bar for competitors around the world, China is shifting its manufacturing resources to increasingly sophisticated goods, as shown by its rapid emergence as a global powerhouse in the auto-parts industry.

Just a few years ago, Chinese-made automotive components were plagued by a reputation for poor quality, and often cost more than U.S. or German parts. Detractors said the precision engineering required for the best parts was beyond the reach of inexperienced Chinese companies and their low-cost workers.

Last year, however, China for the first time exported more parts than its fast-growing auto industry purchased from abroad. Quality has improved so much that major Western auto makers like Volkswagen AG and DaimlerChrysler AG say they plan in coming years to buy billions of dollars of Chinese-made components -- such as brakes, fuel pumps, wheels and steering systems.

Those gains show how China continues to evolve as a manufacturer, posing new challenges for rivals in the U.S., Europe and Japan. After earning its stripes as a maker of simple consumer goods, such as furniture and textiles, China has branched out, quickly coming to dominate more labor-intensive parts of the consumer-electronics business, such as computer assembly, and moving into a broader range of industries.

The country's production of machinery and transportation equipment has surged, and export of those goods -- which range from auto parts to forklifts to vacuum cleaners -- totaled $352 billion last year, a fourfold increase from 2000.

Meanwhile, motor-vehicle production here has nearly tripled, and China is on pace to overtake Germany as the world's third-biggest auto maker. It has become the world's second-largest car market in terms of sales as millions of Chinese buy cars for the first time. Millions more are expected to do so as their incomes rise and car prices fall.

Now, "China competes in the entire range of products from telecom equipment to textiles," says Hafiz Pasha, director of the United Nations Development Program's Asia bureau.

The transition comes at a sensitive time for the U.S. and Europe, which have been finding it harder to hold on to high-paying manufacturing jobs. Employment in the U.S. auto-parts industry fell to about 644,000 in 2004 from about 721,000 in 2002, according to government figures.

More job losses could be on the way: Some major U.S. parts makers -- including Delphi Corp., which has plants in China -- have sought bankruptcy-court protection. And small and midsize suppliers, which often don't have the resources to set up lower-cost operations abroad, are facing growing pressure.

"In the past two years, Chinese bids for auto-parts orders have driven customer price targets to a level below our costs on some products," said Larry Denton, chairman and chief executive of Rochester Hills, Mich., parts maker Dura Automotive Systems Inc., at a recent government hearing in the U.S.

..."When we started exporting in 1997, people argued that you couldn't make" auto parts cheaper in China, says Jack Perkowski, chief executive of Beijing-based parts maker Asimco Technologies Ltd. "People also argued that China would never be a large car market."

Now, he says, "the conventional wisdom is that China can copy but not create. That's going to go too."

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