Reflection
First Half: Life as a Physicist
I believe this was my first time reading a semi-biography of a physicist—I say semi because Derman turns to his life as a quant in the second half—so it was quite a new experience for me.
Although I was unable to understand more than half of what he had to say about physics, I appreciated Derman’s efforts to distill complex concepts into simple sentences, often with the help of real-life analogies.
What I enjoyed most, however, was Derman’s honest account of what it meant to live as a physicist at the time, as well as his personal reflections on the culture and landscape of physics.
Some of the stories that stayed with me:
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Physics at the time—though I cannot say for certain how much of what he describes still applies today—was a fiercely results-oriented field. Consequently, only the exceptional few were truly sought after, while many otherwise capable physicists experienced recurring periods of depression and professional insecurity throughout their lives.
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The story of Lee and Yang was particularly memorable. Even the greatest physicists, who deeply appreciated the grandeur of the universe, were not immune to impatience and conflict in their relationships with others. I could not help but find something quietly ironic—and deeply human—about that.
Second Half: Life as a Quant
I knew Derman as a prominent industry practitioner who had written several popular books and had once worked in Goldman Sachs’s Quantitative Strategies Group, but that was about all I knew. I had little sense of the magnitude of his influence on the field, and I was surprised to learn just how influential a figure he had been.
Some of the stories that stayed with me:
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Fischer Black, then a partner at Goldman Sachs, was an unorthodox thinker who prioritized practicality and simplicity over rigor and completeness. I suspect Derman himself was strongly influenced by Black’s style of research. That influence may later have been reflected in the relatively accessible research pieces on technical subjects published by Goldman Sachs’s Quantitative Strategies Group.
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Derman, who also helped develop the Black-Derman-Toy model for interest-rate derivatives, was one of the pioneers of local volatility modelling. Unlike the Black-Scholes-Merton model, which assumes constant volatility, local volatility allows volatility to vary with both the price of the underlying asset and time. This made it possible for the model to reproduce the implied volatility surface observed in the market.
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One theme emphasized repeatedly throughout the book is that there will never be a universal model of finance, because finance is closer in nature to the social sciences than to the natural sciences. Its “laws” are subject to regime changes; feedback mechanisms arising from reflexivity can become dominant forces; and behavioral biases repeatedly violate the rationality assumptions on which many models depend. Derman seemed to deal with these complications by focusing not on whether a model was perfectly accurate, but on whether it was useful to its users—particularly traders.
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Derman explains that, unlike physics, modelling in finance often involves solving what he calls inverse-scattering problems. Instead of beginning with the laws of nature and deriving observable consequences, one begins with the observed phenomenon and works backward to infer the rules that may have produced it. This is where calibration comes into play: calibration forces financial models to adapt to the market data they observe. In other words, the “laws” adapt to the phenomenon rather than the phenomenon following fixed laws.
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I think the period during which Derman worked as a quant was uniquely ripe for physicists and mathematicians. There must have been a certain catharsis in solving difficult financial engineering problems faster than anyone else—and being rewarded with ownership of proprietary knowledge that genuinely no one else in the world possessed. This is, of course, less common today. Many foundational derivatives models have already been established, so new quants are often more likely to review, implement, and maintain existing models than to create entirely new ones.
Overall, it was quite easy to become absorbed in the book. Derman makes a deliberate effort to keep the material engaging while remaining honest and humble—a balance that is not easy to achieve.
One lesson I would take from the book concerns the very meaning of mathematical modelling. Coming from a statistical—or perhaps more broadly data-driven—background, I tended to think of modelling as running regressions or machine-learning algorithms on features that I believed could predict a target variable.
Modelling in physics, however, seemed to involve something deeper: formulating a set of testable rules that could explain the dynamics of a phenomenon, and forcing oneself to resolve ambiguities by expressing those rules in the language of mathematics.
Through that process, one comes to understand the phenomenon more deeply than almost anyone else. To become the owner of that kind of hard-won, proprietary knowledge is both a privilege and a profound source of intellectual joy. After reading this book, I think I understand that feeling a little better.
Memorable Quotes
Like most physicists, I was a reductionist: I believed that you can explain complex things by reducing them to their constituents.
— p. 26
At age 16 or 17, I had wanted to be another Einstein; at 21, I would have been happy to be another Feynman; at 24, a future T. D. Lee would have sufficed. By 1976, sharing an office with other postdoctoral researchers at Oxford, I realized that I had reached the point where I merely envied the postdoc in the office next door because he had been invited to give a seminar in France.
— p. 28
Brilliance seemed paramount in the Columbia physics department. T. D. was willing to supervise only the stellar wunderkinder who often went on to become inordinately young Columbia physics professors. The department developed an incestuous air; the pressure of his presence on his students-turned-faculty, like sons in their father’s house, must have been fierce. Over time they seemed to gravitate towards research problems a little removed from the mainstream, as though searching for clear air to breathe. Unlike Rabi or Schwinger, who took on many more students and generated schools of disciples who propagated out into the world, T. D. never gave birth to anyone of his caliber.
— p. 38
I had imagined postdoctoral life as a sort of priesthood, the blissful apotheosis of a life dedicated to knowledge. In top-notch universities, a postdoc in theoretical physics had no mundane obligations—no teaching, no administration, no fixed hours. What remained was transcendental. You were hired for your research talent. All you had to do was find something conceptually worthwhile that interested you and then work on it. All that mattered was what you achieved. It was simple, but the stakes were high. No one I knew thought much about getting rich or about what they would earn. Everyone hoped to achieve something numinously great and was willing to work an entire lifetime at it. We looked down on professors who ceased “doing physics” once they achieved tenure. As we got older, we took solace in the stories of people who made great discoveries after the age of thirty. It was very different from Wall Street, where I heard twenty-something traders talk about “their number,” the amount of money they figured they needed to be able to quit, certain that they would never have to work again.
— p. 54
I was beginning to become very aware of my limitations. There were people you met in physics who were simply off any scale you could imagine. When I read classic papers by Einstein or Feynman, I realized that though I could understand and utilize their framework, I could never have created it. My wife, having left physics for biology, knew something about both areas, and said that even the smartest biologist didn’t leave you feeling that they were out of your league. Physics was different.
— p. 63
I had now entered a world in which people ten or more years younger than me found it necessary to crack the whip when I didn’t trot fast enough. But in truth, it wasn’t that bad—Wall Street has been always meritocratically discourteous. It never seemed to me that great an indignity. In the nineteen years that have elapsed since then, I have been ordered about by young traders, had my back patted and my upper arm encouragingly squeezed in elevators by newly minted partners, and, once, been pushed across the trading floor and cursed in full view of everyone there by an angry and foul-mouthed saleswoman. There is a general lack of respect for age in all of this that makes you disregard your own age, and I like it.
— p. 135
Fischer was precise and organized, quite punctilious. Every day he ordered the same ascetically healthy meal delivered to his desk. He liked to wear a Casio information-storing watch, which prompted some of his employee-admirers to do likewise. In his office giving audience, if you said something he found useful, he wrote it down with his fine pointed mechanical pencil on a fresh sheet of his ruled white pad, and then tore it off and inserted it into a new manila folder which he labeled and then placed in one of his file drawers. In an article published after his death, Beverly described the 6,000 files he left behind, now archived at MIT.
— p. 150