Talkin' bout my generation

Michael Lewis, writing in the Times magazine, profiles John Seo, one of the new generation of quant hedge fund managers. Seo trades catastrophe bonds, instruments that let insurers and reinsurers transfer risk from natural disasters. An interesting point discussed later in the article is that the typical premium charged for rare event insurance (tail risk) is about 4-5 times the expected loss, and that this rough rule of thumb is found across many different kinds of risk.

Seo's path to finance is a typical one for physicists in my generation, including the objections from his traditional Asian family :-) People often ask me why I am interested in quant finance. If the majority of friends you knew in college and graduate school (all of them brilliant and highly trained scientists) ended up doing something different than you, wouldn't you naturally be curious about what they were up to? The most common sentiment I've heard expressed by former physicists who are now in finance is "I can't believe I waited so long to leave"!

Whatever image pops to mind when you hear the phrase “hedge fund manager,” Seo (pronounced so) undermines it. On one hand, he’s the embodiment of what Wall Street has become: quantitative. But he’s quirky. Less interested in money and more interested in ideas than a Wall Street person is meant to be. He inherited not money but math. At the age of 14, in 1950, his mother fled North Korea on foot, walked through live combat, reached the United States and proceeded to become, reportedly, the first Korean woman ever to earn a Ph.D. in mathematics. His father, a South Korean, also came to the United States for his Ph.D. in math and became a professor of economic theory. Two of his three brothers received Ph.D.’s — one in biology, the other in electrical engineering. John took a physics degree from M.I.T. and applied to Harvard to study for his Ph.D. As a boy, he says, he conceived the idea that he would be a biophysicist, even though he didn’t really know what that meant, because, as he puts it, “I wanted to solve a big problem about life.” He earned his doctorate in biophysics from Harvard in three years, a department record.

His parents had raised him to think, but his thoughts were interrupted once he left Harvard. His wife was pregnant with their second child, and the health plan at Brandeis University, where he had accepted a job, declared her pregnancy a pre-existing condition. He had no money, his parents had no money, and so to cover the costs of childbirth, he accepted a temp job with a Chicago trading firm called O’Connor and Associates. O’Connor had turned a small army of M.I.T. scientists into options traders and made them rich. Seo didn’t want to be rich; he just wanted health insurance. To get it, he agreed to spend eight weeks helping O’Connor price esoteric financial options. When he was done, O’Connor offered him 40 grand and asked him to stay, at a starting salary of $250,000, 27 times his post-doc teaching salary. “Biophysics was starved for resources,” Seo says. “Finance was hurling resources at problems. It was almost as if I was taking it as a price signal. It was society’s way of saying, Please, will you start solving problems over here?”

His parents, he suspected, would be appalled. They had sacrificed a lot for his academic career. In the late 1980s, if you walked into the Daylight Donuts shop in Dallas, you would have found a sweet-natured Korean woman in her early 50s cheerfully serving up honey-glazed crullers: John’s mom. She had abandoned math for motherhood, and then motherhood for doughnuts, after her most promising son insisted on attending M.I.T. instead of S.M.U., where his tuition would have been free. She needed money, and she got it by buying this doughnut shop and changing the recipe so the glaze didn’t turn soggy. (Revenues tripled.) Whatever frustration she may have felt, she hid, as she did most of her emotions. But when John told her that he was leaving the university for Wall Street, she wept. His father, a hard man to annoy, said, “The devil has come to you as a prostitute and has asked you to lie down with her.”

A willingness to upset one’s mother is usually a promising first step to a conventional Wall Street career. But Seo soon turned Wall Street into his own private science lab, and his continued interest in deep questions mollified even his father. “Before he got into it, I strongly objected,” Tae Kun Seo says. “But now I think he’s not just grabbing money.” He has watched his son quit one firm to go to work for another, but never for a simple promotion; instead, John has moved to learn something new. Still, everywhere he goes, he has been drawn to a similar thorny problem: the right price to charge to insure against potential losses from extremely unlikely financial events. “Tail risk,” as it is known to quantitative traders, for where it falls in a bell-shaped probability curve. Tail risk, broadly speaking, is whatever financial cataclysm is believed by markets to have a 1 percent chance or less of happening. In the foreign-exchange market, the tail event might be the dollar falling by one-third in a year; in the bond market, it might be interest rates moving 3 percent in six months; in the stock market, it might be a 30 percent crash. “If there’s been a theme to John’s life,” says his brother Nelson, “it’s pricing tail.”

And if there has been a theme of modern Wall Street, it’s that young men with Ph.D.’s who approach money as science can cause more trouble than a hurricane. John Seo is oddly sympathetic to the complaint. He thinks that much of the academic literature about finance is nonsense, for instance. “These academics couldn’t understand the fact that they couldn’t beat the markets,” he says. “So they just said it was efficient. And, ‘Oh, by the way, here’s a ton of math you don’t understand.’ ” He notes that smart risk-takers with no gift for theory often end up with smart solutions to taking extreme financial risk — answers that often violate the academic theories. (“The markets are usually way ahead of the math.”) He prides himself on his ability to square book smarts with horse sense. As one of his former bosses puts it, “John was known as the man who could price anything, and his pricing felt right to people who didn’t understand his math.”