what do these Wall Street “quants” actually do?
In: Economics
To build on the excellent answer above, it helps to understand how someone decides how much they think a stock is worth. The ELI30 is it is the net present value of all future cash flows divided by the number of shares of stock outstanding. To break that down, net present value just means stuff in the future is worth less than today. So $100 in 2025 is worth less than $100 in 2022 is worth less than $100 in 2020. Future cash flows is exactly what it sounds like—the company buys a new machine for a million dollars, that’s a million dollars negative cash flow. The company sells a widget for 15 dollars, that’s 15 dollars of positive cash flow. So you take all the projected future cash flows from everything this company will do from now until eternity, you reduce some of those cash flows in size because they’re far in the future, and you’ve got your net present value of all future cash flows. That’s what the company is worth. Divide by the number of shares in the company and you find out what each share is worth.
What some of these quants do is build models to help them figure out what a share should be worth based on the above. If their model then says a share should be worth $60 but it’s available on the market for $35, they’d suggest to their employer that the stock is undervalued and they should buy it.
Broadly, they create and estimate statistical models of financial assets. The ‘quant’ is short for ‘quantitative’, which means they try to make trading decisions based on hard (quantifiable) data rather than subjective evaluations of an investment opportunity. Those statistical models can take all different shapes and sizes. Some may be mathematically simple but focused on speed to take advantage of trading opportunities that are only briefly available. Others can be much more complex and used to inform long-term trading strategies. The details are, of course, proprietary.
Originally (the 80’s & 90’s), the job of quants was to determine how much brokerage houses would charge clients for derivatives like futures and options based on how much it would cost to hedge the risk of the product by buying and selling the underlying instrument. If they priced it too low the firm would lose money but if they priced it too high another firm would undercut them. Back then quants did NOT try to predict the market.
Now they do, much more math and computing resources are available now and quants try to forecast the characteristics of the return distribution of a portfolio of investments or try to construct the best portfolio for a range outcomes. The idea is to achieve the highest return with the lowest risk.
Latest Answers