Inside Volatility Filtering: Secrets of the Skew, 2nd Edition

Foreword

The views represented herein are the author's own views and do not necessarily represent the views of Morgan Stanley or its affliates, and are not a product of Morgan Stanley research.

A revolution has been quietly brewing in quantitative finance for the last quarter century. In the 1980s and 1990s, quant groups were dominated by physicists and mathematicians well versed in sophisticated mathematical techniques related to physical phenomena such as heat flow and diffusion. Rivers of data flowed through the canyons of Wall Street, but little thought was given to capturing the data for the purpose of extracting the signal from the noise. The dominant worldview at the time viewed finance as primarily a social enterprise, rendering it fundamentally distinct from the physical world that the quants had left behind. I think that most quants of the time would have agreed with George Bernard Shaw, who said that:

Hegel was right when he said that the only thing we learn from history is that man never learns anything from history.

When an econometrician named Robert Litterman interviewed for a position at Goldman Sachs in 1986, the legendary Fischer Black began the interview by asking, “What makes you think that an econometrician has anything to contribute to Wall Street?”

I suspect we will never know how the candidate answered that question, but had the candidate been Mark Twain, the answer would surely have been that:

History doesn't repeat itself, but it does rhyme.

Six years ...