Books, Corporate Life, Quantitative Finance

Quants

If you are a quant, you are a mathematician with an advanced degree in mathematics or physics. Your work is based on both academic research and professional, peer-reviewed publications. You take your inputs from them, apply your own formidable intelligence to come up with a stochastic pricing model that you think will work exceptionally well for a class of products. You will also need the details of the products. Your output is, of course, a pricing model of your own, or an implementation of a pricing model from the literature. This is your primary work unit.

Quant perspective

In order to make use of this pricing model, it will have to be validated. Then a set of products using the pricing model will be defined and submitted for approval. Once approved, with the help of trade inputs and market data, each of the products can be priced and booked into the trading platform. But such activities are outside the sphere of interest and influence of the quant. To them, how a product is instantiated into a trade is pretty irrelevant and trivial. It is merely a question of specifying the trade and market inputs to the pricing model. Even how various products are derived is mechanical, and all the “real” work is done in the pricing model.

This perspective, though accurate and functional for a quant, is pretty far removed from the view of the rest of the bank, which is why quants sometimes have the dubious reputation of being out of touch with the industry. The point is not so much that they have to change their perspective, but they should appreciate that there are other equally valid perspectives held by other business units they interact with, and make an effort to know them.

Life and Death, Philosophy

How Should I Die?

I have reached the age where I have seen a few deaths. And I have had time to think about it a bit. I feel the most important thing is to die with dignity. The advances in modern medicine, though effective in keeping us alive longer, may rob us of the dignity with which we would like to go. The focus is on keeping the patient alive. But the fact of the matter is that everybody will die. So medicine will lose the battle, and it is a sore loser. That’s why the statements like “Cancer is the biggest killer” etc. are, to some extent, meaningless. When we figure out how to prevent deaths from common colds and other infections, heart disease begins to claim a relatively larger share of deaths. When we beat the heart disease, cancer becomes the biggest killer, not so much because it is now more prevalent or virulent, but in the zero-sum game of life and death, it had to.

The focus on the quantity of life diminishes its quality near its tail end due to a host of social and ethical considerations. Doctors are bound by their professional covenants to offer us the best care we ask for (provided, of course, that we can afford it). The “best care” usually means the one that will keep us alive the longest. The tricky part is that it has become an entrenched part of the system, and the default choice that will be made for us — at times even despite our express wishes to the contrary.

Consider the situation when an aged and fond relative of ours falls terminally sick. The relative is no longer in control of the medical choices; we make the choices for them. Our well-meaning intentions make us choose exactly the “best care” regardless of whether the patient has made different end-of-life choices.

The situation is further complicated by other factors. The terminal nature of the sickness may not be apparent at the outset. How are we supposed to decide whether the end-of-life choices apply when even the doctors may not know? Besides, in those dark hours, we are understandably upset and stressed, and our decisions are not always rational and well-considered. Lastly, the validity of the end-of-life choices may be called into question. How sure are we that our dying relative hasn’t changed their mind? It is impossible for any of us to put ourselves in their shoes. Consider my case. I may have made it abundantly clear now that I do not want any aggressive prolongation of my life, but when I make that decision, I am healthy. Toward the end, lying comatose in a hospital bed, I may be screaming in my mind, “Please, please, don’t pull the plug!” How do we really know that we should be bound by the decisions we took under drastically different circumstances?

I have no easy answers here. However, we do have some answers from the experts — the doctors. How do they choose to die? May be we can learn something from them. I for one would like to go the way the doctors choose to go.

Books, Corporate Life, Quantitative Finance

Trade Perspectives

The last section of this post series is on trade perspectives. In fact, our earlier sections on the static structure of the bank and the temporal evolution of the trade have been in preparation to this last section. In the next couple of posts, we will see how the quants, quantitative developers and the middle office professionals (and the rest) see trades and trading activity. Their views are important and need to be accommodated in the design philosophy of any trading platform.

Where do these perspectives come from and why do we need to know about them? Trade perspectives are based on the work paradigm specific to each business unit. Because of what aspect of the trading activity a group focuses on, they evolve a paradigm, or a mental model, that works best for them.

In order to understand, let’s take a look at how we work with a modern personal computer. The paradigm we are presented with is one of a desk and a filing cabinet. So we have a desktop, folders and files. They have become so natural for us now that we cannot imagine another way of interacting with a computer at all. The Internet, on the other hand, is built on a paradigm of something that hovers over us, which is why we “down”-load stuff from it and “up”-load stuff into it. But the programmers and architects who develop such paradigms often do work with different and less known paradigms as well; for instance we have ports and sockets and streams and so on.

If we do not appreciate the work paradigm, we will find the jargon that comes with it mysterious and incomprehensible. This is especially true if we are to work on projects that cut across multiple business units with differing paradigms.

Trade perspectives

To illustrate it further with an example from our trading world, let’s look at how we identify a trade. The quants really do not care about the trade identification number; for them, it is the pricing model that is the basic unit that they work with. The quantitative developer, on the other hand, would like the identifier to be something unique per trade. A structurer would like to have one identifying reference for the trade with possible sub IDs for the individual sub trades that make up a structure. While this requirement is easy enough to implement, the software architecture also has to cater to trade cancellation and amendment requirements from Front Office and Middle Office. What happens when a structure is modified or canceled? How do we find and deal withall the related trades? This problem will almost invariably ends up requiring a link ID in the database. Trade number amendments on a live deal create problem for documentation and operations staff as well, who might demand another immutable external reference number attached each trade. Audit will require integrity and indelibility on everything, demanding database record duplication. As we can see, the perspectives and work paradigms of each business unit translate to often conflicting requirements on the program design at a fundamental level. It is for this reason that we will take close look at the trade perspectives in the following posts of this series.

Books, Corporate Life, Quantitative Finance

Summary — Life of a Trade

With that we have come to the end of our discussion on trade lifecycle. We talked about pre-trade activities such as the quant work on pricing model, and its validation by an independent team. On a per-trade basis, we have the sales and credit check activities. Once a trade is initiated, it goes through the initial validation work by Middle Office, followed by regular processing by a large number of teams, such as Market Risk Management for limits monitoring and reporting, Product Control for valuation checks and reserve calculations, and trading desks for hedge rebalancing and risk management. During the termination phase of the life of a trade, it is the back office teams that are active in settlements and reporting.

Trade lifecycle summary

As we saw, most of the activities, especially during the inception and up to the termination of a trade, the trading platform plays a crucial role in mediating the processes and conveying the trade from one business unit to the next. But these different business units work with their own entrenched work paradigms, and their perspective on what a trade is or what their work involves can be radically different from one another. Since the trading platform cuts across multiple teams, it has to cater to these differing perspectives, which is the last section of this series starting the next post.

Creative, Parenting, Work and Life

How to Take Beautiful Pictures

I recently learned a technique in portrait photography from this artist friend of mine. He told me that one could use backlight to create beautiful portraits. I had always thought that backlight was a bad thing, which was something my dad taught me. I trusted him. After all, he used to take impressive portraits with his faithful Yashica Electro 35. Later on, after acquiring my first SLR, I spent a lot of time understanding the merits of TTL (Through-The-Lens) metering and fill-flash to counter the evils of backlight.

So when Stéphane told me that the best way to capture nice portraits is to have the sun behind my subject, I was shocked. But experience had taught me to always pay attention to Stéphane. He used to take better pictures with a drugstore paper camera than I could with my prized Nikon SLR. He was right, of course. With the sun behind them, your subject doesn’t have to squint and screw up their eyes against the light. They are less distracted and tend to smile more readily. And, most importantly, their backlit hair looks magical.

To do backlight portraits right, however, you have to be careful about a couple of things. First, make sure that you don’t have direct sunlight on your lens, which will create unseemly flares. I’m sure the next time I meet him, Stéphane will teach me how to use flares to my advantage. But for now, I would avoid direct light on the lens. Look for a spot in the shade. For instance, look for a tree casting a shadow. Don’t try to stand in the shadow, but try to get the shadow on your face, which is where the camera is likely to be. Get the tree in between you and the sun. How do you do it in practice? Just turn around and look at the shadow of your head; if it is hidden within another bigger shadow, you are safe. If not, move.

Stephane in CassisThe second thing to pay close attention to is the background. It cannot be too bright, or the average metering of your camera will underexpose your subject’s face. (Again, another dictum the creative photographer will probably scoff at). Look at the portrait of Stéphane himself, taken by me the day after I got the revelation about backlight. You can see my reflection on his glasses, trying to crouch low so as to get the dark hill in the frame rather than the bright beach sand. I think this is a nice photo, at least technically. Stéphane looked at it and complained that he looked like a James Bond villain!

Kavita in Carnoux
Here is a backlit portrait of my lovely wife. See how the framing includes the dark shrubbery in the background giving the nice contrast and brightness to the face. All right, I will admit it, the composition was probably a lucky accident. But still, I wouldn’t have attempted this snap unless I knew that backlight could be good. So be bold, experiment with backlight. I’m sure you will like the results.

Here are some dramatic backlight portraits by a gifted photographer.

Books, Corporate Life, Quantitative Finance

Termination

The last lifecycle event of a trade is, of course, its termination. It can be triggered for a variety of reasons. Whatever the reason may be, when a trade is terminated, it calls for settlements and documentation archival by Back Office. In addition, it may trigger public disclosures (in an aggregate form) by Finance, and incentive adjustments by Human Resources.

The common reasons for trade termination and the workflow it triggers are depicted in the figure below.

Trade termination

  • Trade Maturity: When a trade or an option reaches maturity, it gets terminated, which is the most uneventful mode of trade termination.
  • Option Exercises: If the bank or its counterparty exercises an option, it gets terminated. Exercises can take place any time during the lifetime of a trade, or only on specific dates, depending on the termsheet description of the product involved.
  • Barrier Breaches: Barrier options (or knock-in and knock-out options) may breach the pre-defined barriers and may get terminated generating settlements or new trades.
  • Target Triggers: Instruments that accumulate toward a target (such as range accruals or target redemption forwards) may get terminated when the target is reached.
  • Trade Novation: Novation is the special process by which the trade counterparty changes. In effect, the original counterparty sells the the trade or the option to another one. When a novation happens, the original trade is terminated and a new one initiated with special characteristics.
Corporate Life, Humor, Life and Death, Malayalam

Retirement — a Wife’s View

In connection with my recent retirement, my wife sent me an article (a speech given by someone on how to retire happily) which made several interesting points. But even more interestingly, it started with a funny story. Here it is:

In a small village in Kerala, a devout christian passed away. The local priest was out of station, and a priest from an adjoining village was called upon to deliver the eulogy. “Ladies and Gentlemen,” began the venerable pastor with the coffin before him. “Here lies dead before me a rare human being of this village with outstanding qualities. He was a gentleman, a scholar, sweet of tongue, gentle of temper and very catholic in outlook. He was generous to a fault and ever smiling.” The widow of the deceased sprang up and screamed, “Oh my God! They are burying the wrong man!”

True to form, this gentleman concluded his speech with another story.

First God created the cow and said, “You must go with the farmer everyday to the field, and suffer under the sun all day long, have calves, give milk and help the farmer. I give you a span of sixty years.” The cow said, “That’s surely tough. Give me only twenty years. I give back forty years.”

On Day Two, God created the dog and said, “Sit by the door of your house and bark at strangers. I give you a span of twenty years.” The dog said, “Too long a life for barking. I give up ten years.”

On the third day, God created the monkey and said to him, “Entertain people. Make them laugh. I give you twenty years.” The monkey said to God, “How boring! Monkey tricks for twenty years? Give me only ten years.” The Lord agreed.

On the fourth day, God created Man. He said to him, “Eat, sleep, play, enjoy and do nothing. I will give you twenty years.”

Man said, “Only twenty years? No way! I will take my twenty, but give me the forty the cow gave back, the ten that the monkey returned, and the ten the dog surrendered. That makes it eighty. Okay?” God agreed.

That is why for the first twenty years we sleep, play, enjoy and do nothing.
For the next forty years we slave in the sun to support our family.
For the next ten years we do monkey tricks to entertain our grandchildren.
And for the last ten years we sit in front of the house and bark at everybody.

Well, I managed to cut down my forty cow-years to a mere twenty. Here’s hoping that I will get similar discounts on my monkey and dog years!

Books, Corporate Life, Quantitative Finance

Validation and Processing

Once a trade is booked into the trading platform database, it triggers a whole chorus of validation and daily processing. The validation process is a to-and-fro dance between the trading desks in Front Office and the control units in Middle Office, all mediated by the trading platform. The traders may insert a trade on an experimental basis. Once they are convinced that it is a viable trade, they push it to a confirmed state, which will be picked up by the treasury control unit. If the traders decide to discard the trade, the trade ends up in the trash pile (but never deleted permanently). The control unit typically works in a four-eye, double validation mode. They verify the trade inputs, and control limits such as the number of trades allowed for a particular product. If the trade passes their tests, they set its status to a validated state, which triggers a second level of checking. If the trade fails either level, they are pushed back into a state that allows the traders to either amend it or discard it.

Trade validation

Once the trade is fully validated, the processing part begins. It involves multiple teams and multiple perspectives, starting from how a trade should be identified to what the basic information unit that should be identified.

Daily Processing

As shown in the figure above, regular processing takes place in various business units.

  • Trading Desks monitor trades for hedging and rebalancing, monitoring profit and loss (P/L), and staying within the risk limits. The senior traders get distilled information from the junior ones through this regular processing and take appropriate actions.
  • Middle Office plays a crucial role in regular process. They monitor target and barrier breaches, rate fixings and option exercises, cash flow generation, and spawning other cash trades. They generate (with the help of the trading platform) appropriate accounting triggers for Back Office to act on, in order to perform settlements, trade confirmation, documentation archival etc.
  • Product Control is another business unit embedded within the middle office that actively monitor the P/L on a daily basis, with a view to explaining their movements based on the sensitivities and market movements, providing an independent computation of the profitability of the trading activity. Their computations of reserves feed into the finance and human resources departments and affect trader incentives and compensation.
  • Market Risk Management also has hordes of staff employed to perform daily monitoring of trading limits (such as notionals, delta-equivalents etc.) as well as VaR computation, Stress VaR tests. In most banks, they also handle compliance reporting to regulatory authorities and provide concise and actionable intelligence to the upper management who decide the trading strategies.

As we shall soon see, the different and specific focus of each business unit demands a unique projection (which we will call a perspective) of the trading information from the trading platform. This requirement is one of the things that make its design and implementation so challenging.

Life and Death, Philosophy, Physics

Why Do We Drink?

We get in trouble or at least embarrass ourselves once in a while because of our drinking. Why do we still do it? Ok, it is fun to have a drink or two at a party — it gives you a buzz, loosens your tongue, breaks the ice etc. But most of us go way beyond that. We almost always end up regretting it the next morning. But we still do it.

Alcohol actually tastes bad, and we have to add all kinds of sodas and fruit juices to mask it. It is a depressant, so if we drink it when we are sad, it makes us sadder. It is toxic to our liver, kills our brain cells and makes us do silly things like puke and generally make an ass of ourselves. But, by and large, most people who can get their hands on it, drink it.

I am not talking about alcoholics who have trouble controlling their urges (although I believe most of us are budding alcoholics). I am not even talking about why we start drinking — that could be because of peer pressure, teenage dares, curiosity etc. I’m talking about those of us who continue drinking long after that sweet buzz that alcohol used to give us is history.

I do have a theory why we drink. But I have to warn you — my theory is a bit looney, even by the generous standards of this Unreal Blog. I think we drink because it alters our sense of reality. You see, although we don’t usually articulate it or even consciously know it, we feel that there is something wrong with the physical reality we find ourselves in. It is like a tenuous veil surrounding us that disappears the moment we look at it, but undulates beyond the periphery of our vision giving us fleeing glimpses of its existence in our unguarded moments. Perhaps, if we can let our guard down, may be we can catch it. This vain and unconscious hope is probably behind our doomed attractions toward alcohol and other hallucinants.

Although the veil of reality is tenuous, its grip on us is anything but. Its laws dictate our every movement and action, and literally pull us down and keep us grounded. I think our minds, unwilling to be subjugated to any physical laws, rebel against them. Could this be behind our teenagers’ infatuation with Stephenie Meyer’s vampire stories and Harry Potter’s magic? Isn’t this why we love our superheroes from our childhood days? Do we not actually feel a bit liberated when Neo (The One in Matrix) shows that physical rules don’t apply to him? Why do you think what we worship are the miracles and the supernatural?

Well, may be I am just trying to find philosophical reasons to get sozzled. Honestly, I’m feeling a bit thirsty.

Corporate Life

Capitalism vs. Corporatism

During a recent conversation with him, this client of mine used the word “corporatist” to describe his country (US of A). He said twenty years ago, they were a capitalist country, not a corporatist one. Now, this is a kind of fine distinction that I’d love to talk about. To me, it was a surprising and illuminating distinction, one that cleanly dissects and clears up the economic confusion of our times. And I had to write about it.

Everybody knows what capitalism is. It is the market-driven, private-ownership-centric economic system where selfish motives bring about collective happiness, according to Adam Smith. This way of life has been accepted as the “good” system, and stands in stark contrast with the collective, community-owned economic system with notions of robust social redistribution of wealth — communism or socialism. Although the latter does sound like a better and more moral ideal, at least in principle, it never did pan out that way.

Corporatism is not as well-known as capitalism. At least, I didn’t know that such a word existed. But the moment I heard it, I could guess what it meant. It points to the end product of unbridled capitalism, one with no government control, or even moral hangups. In my view, it happens this way — once you have private ownership, some people get richer than the rest. There is nothing wrong with that; in fact, it is a mathematical certainty. But then, money gives those lucky guys more power, and access to ways in which they can make more money. For instance, they can influence the political system, and through it the fiscal and taxation policies. Also, private ownerships can be pooled together to form economic organisms that can sustain themselves. These organisms are, of course, corporate bodies. They exert power through their collective wealth to an even greater extent than the good old capitalists.

A curious thing happens when capitalists (simple rich folks, that is) get sidelined by corporations. The money and power get separated in a strange way. The board members and CEOs who control the corporate bodies end up wielding power, instead of the owners. They are entrusted with the task of guarding and growing the capital. They find novel strategies to do this, like taking advantage of tax loopholes and tax havens, and engaging in unsavory business practices (like mixing any damn white powder with baby food, for instance). As long as they succeed in their remit of growing the capital, they seem to absolve themselves of the moral implications of their actions. For their services, they pay themselves handsome rewards. Note that the corporatists (the operators) pay themselves; it is not as though the capitalists (the owners) pay them, wherein lies the separation of power and money.

When you bring in the financial system whose primary function is capital management, the separation of power, money and morality takes on a new dimension. So banks, with no intrinsic economic value of their own, turn out to be too big to fail, and the system rearranges itself in such way that even when they do fail, it is the people farthest removed from power and money are the ones who pay for it. The high-flying bankers and senior managers get golden parachutes because they have both power and money. The trickle-down economy envisioned in pure capitalism (an optimistic vision to begin with) only trickles through channels drawn by the corporate overlords.

These unfair trickles did not bother us (the middle class) for a long time because they were not all trickling away from us. Now that they have started to, we are beginning to sit up and protest. I sympathize with my American client. Now that the corporatists are after our little trickles, we hate corporatism.