bindex_derman.qxd 7/21/04 12:18 PM Page 273

Index

A American Stock Exchange, A Programming Language (APL), 114 options conference,Amex, 154 Academic jobs, scarcity, 51 warrants, 217 Academics, isolation, 87–88 Analytics (company), 119 Achyuthuni, Rao, 219 Anderson, P.W., 27 Adams, Scott, 103 Animorphic (company), 182 Adjustable Rate Mortgage (ARM) Anthroposophists, 89 ARM-based structures, 196 APL. See A Programming Language idiosyncrasies, 192 Applied mathematics 21 pools, 196–198 Applied physics, employment, 92 prepayment rates, regression model, Arab oil embargo (1973), 4 201 Arb group. See Meriwether research group, 190 Area 10. See Bell Laboratories Adler, Dennis, 141 Area 90 (Network Systems). See Bell Adler, Margot, 96 Laboratories AI. See Artificial intelligence ARM. See Adjustable Rate Mortgage Akers, Karen, 96 Aron, J., 205 Algorithmics (financial software Art of Computer Programming,The company), 179 (Knuth), 114 Allen, Paul, 115 Arthur D. Little and Co., 144 Allstate (company), 6 Artificial intelligence (AI), Goldman Amazon.com, 108 approach, 208 American Express Asian call option, purpose, 222 merger, 179COPYRIGHTEDAspen MATERIAL Center for Physics, 57, 81 American Finance Association, 241 Asymetrix (company), 115 American Mathematical Society, 78 Atomic physics, 21, 38, 82 American mortgage market, size, AT&T. See Bell Laboratories 192 advanced switching systems, 4 American Physical Society, 76 business uniform, 126 meeting (1969), 94 employment, view of, 105 American put value, closed-form penal colony, experienced as, 95 solution (search for), 97 share, future price (variation), 153

273 bindex_derman.qxd 7/21/04 12:18 PM Page 274

274 INDEX

AT&T Technical Journal, 113 Members of Technical Staff (MTS), At-the-money option, 232 98–101 At-the-money put, 226 programming duties, 108 Auguries of Innocence (Blake), 90 treatment, 102 AutoBond (Diller), creation, 124, 179 space program funding, 93 Average call option, purpose, 222 Bell System Technical Journal, 100 Avery, Oswald, 77 Bell Telephone Companies, 103 Bellcore (company), 103 B Bellow, Saul, 72 Baby Bells, divestiture from AT&T, Bergier,Alex, 229–231 103 Berk, Jonathan, 139 Back-of-the-envelope methods, 199 Berkeley University, 3, 105 Backus, John, 111–112 Bernstein, Jeremy, 57, 80 Backus Normal Form (BNF), 112 Beta decay, 35 Baker, Howard, 154 Bettelheim, Bruno, 72 Bank of America, partnership. Bezos, Jeff, 108 See D.E. Shaw & Co. BGM. See Brace-Gatarek-Musiela Bankers Trust, 252 Big Bang, 41 Bannister, Roger, 57 Binomial model, 234–235 Bardeen, John, 100 Cox-Ross-Rubinstein model, 130, Barfield, Owen, 72 135 Barrier options Binomial trees, 235. See also Implied hedging gold production with. See binomial tree Long-term barrier options Bio-informatics programs, 180 jump probability/size, sensitivity to, BK. See Black-Karasinski 233 Black, Fischer, 139–140, 143–144, BDT. See Black-Derman-Toy 155–156 Bear Stearns, 126, 178–179 awards, 171, 261 mortgage portfolio valuation clarity/directness/informality, system, 124 167–168 Bég, Mirza Abdul Baqi, 78, 119 collaboration, 154, 188 Bell, Beverly, 150, 160 death, 172 Bell Journal of Economics and disapproval, 148–149 Management Science, 101 first meeting, 146–148 Bell Laboratories (AT&T), 4, 41, 81 independent thinking, 171 Area 10, 100–101, 113 meetings, 167 Area 90 (Network Systems), 100 patience, 162 arrival, 141–142 precision, 148–150 bureaucracy re-employment by, 204 depth of, 187 speech, 202 irrationality, 103–104 view of quant groups, 218 company rules, 96–97 Black box computerized statistical employment, 92–94 arbitrage, 13 exit, 126–127 Black-Derman-Toy (BDT) model, managerial hierarchy, 99–100 160–162 manageriality, cult of, 101–102 application, 190 bindex_derman.qxd 7/21/04 12:18 PM Page 275

INDEX 275

availability, 199 Bloomberg (financial software com- development, 234, 263 pany), 5 equal-period version, 163 BNF. See Backus Normal Form research, publicizing, 169 Bohr, Niels, 2 stochastic factor, addition of, 163–164 Bond options two-dimensional version, model. See Goldman, Sachs and Co. investigation, 165 sale, 133 work, completion, 184 traders, 141 Black-Karasinski (BK) model, 161 valuation models, 130 trees (with variable periods), Bond Portfolio Analysis (BPA), 121, incorporation, 163 187, 190 Black-Scholes calculator, usage, 12 group, 127 Black-Scholes distribution, 152–153 reports, 194 Black-Scholes formalism, 193 Bonds Black-Scholes formula convexity, 11 calibration, 214 duration, 11, 148 what it tells you, 212–213 issuance, 121 Black-Scholes implied volatilities, 227 portfolios, structuring, 139 Black-Scholes model prices, calibrating to, 159 coding, 195 risk system, 179 Black-Scholes options pricing model, traders, analytic/mathematical skills, 5, 143–147 122 calibration, 214 values, comparison, 226 extensions, 241–242 yield, 152 improvement, local volatility 247 Bookstaber, Rick, 154 risk, cancellation, 8 Borror, Jeff, 126 seminar on, 105 Bosco usage, 10, 151 creation, 136 usefulness, 7 demonstration, 147 Black-Scholes single-volatility usage, 141 framework, 244–245 BPA. See Bond Portfolio Analysis Black-Scholes stock option model, Brace-Gatarek-Musiela (BGM) modifications for bonds, 134 model, 161 Black-Scholes value Brattain,Walter H., 100 replication method, convergence to, Brenner, Menachem, 154 170–171 Bronx High School of Science, 39 Black-Scholes-Merton Brookhaven National Laboratories, framework, 168 20, 43–44 model, 172 Bubble chamber20 Blaha, Steve, 103–104, 114 Buckwalter,Alan, 244 Blake,William, 30, 64, 90. See also Buddhism, living principles, 20 Songs of Innocence and Business Analysis Systems Center, 93, Experience,Auguries of 97, 117, 126 Innocence arrival, 108 Blavatsky, Madame, 73 escape from, 112–113 Bloomberg, Michael, 199 location, 100 bindex_derman.qxd 7/21/04 12:18 PM Page 276

276 INDEX

C Citibank, 200, 252 C (programming language), 11, 100, Civilization, discontents, 203 110 Clarendon Labs, 70 usage, 106–107, 113, 135 Clark,Wesley, 262 C++ (programming language), 106, CNN, 263 182 Cobol, usage, 119 usage, 179 Cobrinik, Zach, 120 C (program), generation, 115 Cockney rhyming, 138 C programming (test), 126 Collective behavior, 27 CAC-30, 222 Columbia University, 3, 265 call option, purpose, 221 antinepotism laws, 23 California Institute of Technology computer science courses, 108 (Caltech), 46 dog years, 29 Call options, 132. graduate study, 14, 21 purpose. See also Asian call option; lessons learned, 26 Average call option; CAC-30 physics Callable bonds, 160 class, size, 93 Cambodia,American invasion, 49–50 department, 22 Cambridge Tripos examination, professors, 37 21–22 “quals” (qualifying exams) 30 Cape Town. See University of Cape Commodity inflation (1990s), 91–92 Tow n Compton scattering, Klein-Nishina Capital Asset Pricing Model (CAPM), formula, 70 105, 169–170 Computer languages, grammar, 112 CAPM. See Capital Asset Pricing Computer programs, writing, 30 Model Continuous Time Finance (Merton), 246 Casio, information-storing watch, 150 Continuous-time financial modeling, C-ATS (company), 179 246 CDC IXIS (company), 186 Cooper, Graham, 238, 243 Celestial Seasonings Tea Company, Coppola, Francis Ford, 180 86 Corey, E.J., 29 CERN. See European Center for Cosmic Code,The (Pagels), 79–80 Nuclear Research Cosmic rays, 20 Chang, Lay Nam, 60–62, 66 Cosmology, 80 Chaos: Making a New Science (Gleick), Courant Institute, 3 71 Cox, John C. Chargaff, Erwin, 186 award, 261 Charmed quark, 60 textbooks, 141–142, 224, 235 decay, 66 Cox-Ingersoll-Ross (CIR) model, Chase, Chevy, 140 161 Chogyam Trungpa, 85 Cox-Ross-Rubinstein model. Chomsky, Noam, 112 See Binomial options Christ, Norman, 42–43, 44, 49–50, Cranks, 14 119 Cronin, Jim, 62 CIR. See Cox-Ingersoll-Ross Currency, natural, 213 Circumstance, force, 175 Cvitanovic, Predrag, 70–71 bindex_derman.qxd 7/21/04 12:18 PM Page 277

INDEX 277

D Diffusion, 229–232. See also Stock Dattatreya, Ravi, 120, 130, 132 prices Goldman departure, 141 model. See Jump-diffusion model; introduction, 126 Yield model, for bond options, 148, Digital (Digital Equipment 153–154 Corporation), 108 modification, 134, 150 Dilbert (Adams), 103 D.E. Shaw & Co. See Shaw & Co. Diller, Stan, 120–121, 123, 178 Bank of America, partnership, 110 FSG control, 137 creation, 109 influence, 124 Delta, 225 interview, 124–125 Dembo, Ron, 139 view of quant groups, 218 Demeterfi, Kresimir, 189 Diller’s Dillies, 123 Dengler,Ted,180–181 Dillon Reed, 141 Denmark. See Kingdom of Denmark Dimuons Department of Defense, research distribution, 60 funding, 3–4 events, 58–59 Department of Energy production, theory, 66 research funding, 3–4 speed, 61–62 research grant, 49 Dirac, Paul, 62 Young Investigator Award in High Dissident Row, 138 Energy Physics Research, 86 Distraction, during meditation, 88 Derivative security, 5–6 DLJ (company), 252 characteristic, 6 Doctoral research, 53 Derivatives. See Interest-rate Doctoral thesis, 45 derivatives completion, 49–50 scandals. See Orange County; Doers, contrast. See Thinkers Proctor and Gamble DOS, 140, 147, 219 Derivatives Analysis group, Dot-com bubble, termination, 102 See Goldman, Sachs & Co. Dove,Arthur, 73 Derivatives:The State of the Art, Downs, Jim, 97, 99, 101 (conference) 246 Dress for Success (Molloy), 103 Derivatives (Wilmott), 267 Dumas,Alexandre, 138 Derman, Eva, 49, 53, 54, 57, 58, 62, Dumas,William (Roscoe), 138–139 67, 78, 81–84, 90–94, 120, Dupire, Bruno, 238, 241 125, 130, 135, 201 IAFE talk, 243 Derman, Joshua, 69, 71, 76, 79, 81–84, paper, submittal, 243 86, 90, 91, 94, 95, 97, 116, 117, Duration hedging techniques, 180 125, 130, 136 Dyson, Freeman, 146 Derman, Sonya, 120, 125, 130, 180, 191, 201, 263 E Deutsche Bank, 182 Earle, Dexter, 208–209. See also Dexter Dexter Earle on Derivatives, 208 Earle on Derivatives Dharmadhattu, 88, 118 École Normale Supérieure, 223 Differential equations Economics, excessively formal Feynman-Kaç method, 34 mathematics, 15 bindex_derman.qxd 7/21/04 12:18 PM Page 278

278 INDEX

Education, Steiner (theories), 79 Equity volatility reports. See E.F.Hutton, 179, 252 Goldman, Sachs and Co., Eightfold Way (Gell-Mann), 20, 26, 45 Quantitative Strategies Group Einstein,Albert, 2, 25, 28, 52 Ergener, Deniz, 244 emulation, 27 Ervine, Jeremy, 139 formalism, 33 Essays and Aphorisms (Schopenhauer), 92 imaginary observer, 268–269 Ethical Culture Society, 104 papers, 63 Ettore Majorana (particle physics Elective affinities, 17 summer school), 52 Electricity/magnetism, relationship, 1 Euclid, 15 Electromagnetic force, 35, 47 European Center for Nuclear similarity. See Weak force Research (CERN), 58, 67 Electro-Magnetic Pulse (EMP), study, Web, invention, 68 98 Excel (Microsoft), 115 Electromagnetic theory, 2, 22, 60, 63 Exotic options, 245, 258–259 advanced course, 32 marketing, 223 course, 24 valuation, 244 problem sessions, 62 calculation, 234 understanding, 38 Exxon Labs, 92 Electromagnetism theory (Maxwell), 33, 38 F unified field theories, 25 Fair value. See Security Electron-proton collision. See Inelastic FAST (fixed income research group, electron-proton collision Bear Stearns), 179 Electron-proton scattering. See Inelastic Feder, Mike, 96 electron-proton scattering Fehlleistung (Freud)72 experiment, 42 Feigenbaum, Mitchell, 24–25, 55, 71 Electrons Feinberg, Gerald (Gary), 39–41, 63 distribution in scattering, prediction, Fermi, Enrico, 22–23 47–48 theory. See Weak force muon, similarity, 73–74 Fermilab, 82–83 Elementary particle physics, 19 Feynman, Richard, 19, 23–24, 28, 46. Elementary particles, discovery, 19–20 See also Quantum electro- Elements of Programming Style,The dynamics (Kernighan/Plauger), 108 collision descriptions, 59 Elements of Style,The (Strunk/White), derivations. See Quantum electro- 1089 dynamics EMP. See Electro-Magnetic Pulse diagrams, usage, 48, 112 ENIAC computer, 109 Nobel Prize, 21 Equilibrium Exchanges (Black), papers, 63 168–169 parton model, 47, 50 Equity indexes, options (product), 223 rules, usage, 48 Equity kicker, 222 speaking, 62 Equity options status, 81–82 markets, 217 Feynman-Kaç method. See smile, 226 Differential equations bindex_derman.qxd 7/21/04 12:18 PM Page 279

INDEX 279

Feynman-Kaç theorem, 77–78 Flexible tree, See Implied binomial tree FHLMC, 192 FNMA, 192 Field theory, 52 Foley, Henry, 21 Filofaxes, 109 Formalization, excessive, 167 Finance. See Quantitative finance FORTRAN, 113 modern, revolution in, 7 financial library, 177 relationship. See Physics invention, 111 Financial Analysts Journal, 160, programs, 66, 106, 110 172–173 revolution against, 107, 197 Financial economics, foundation, replaced by C, 135 171 Fourier analysis, 97 Financial engineering, 3 Fourier series, 265 programs, 13 Fractional charge particle, 45 teaching, 43 Frankl,Victor, 44 Financial modeling, philosophical Freud, Sigmund, 72 naivete, 159 Freud and Man’s Soul (Bettelheim), 72 Financial products, increase (1980s), Freund, Peter, 131, 134, 181–182, 263 92 Friedberg, Richard, 32–34 Financial Strategies Group (FSG), Friedberg numbering, 32 120, 121, 123, 125, 126 See Friedman, Bruce Jay, 119 also Goldman, Sachs and Co. Friedman, David, 41 Financial theory Friedman, Jerome, 101 breakthrough, 15 Friedman, Milton, 41 understanding, 8 FSG. See Financial Strategies Group Financial time series, representation, FSLIC guarantee, 176 114 FTSE 100, 223 Finsler spaces, 75 Fundamental physics, 20 First Boston (company), 252 Fury on Earth (Sharaf), 104 IT group, 126 Future scenarios, range (description Fixed Income Analysts Society, of), 214 Hall of Fame, 202 Futures contracts, 148 Fixed Income bond traders, nouveau embedded delivery option valua- riche, 205 tion. See U.S.Treasury bonds Fixed Income Division. See Goldman, Sachs and Co.; Salomon G Brothers Galai, Dan, 154 Fixed-income financial modeling Gansner, Emden, 118–119 infrastructure, construction, Garbasz, David, 131–132, 137–138, 115 178, 179–181, 212 Fixed-income securities, riskiness, Garman, Mark, 105 122 Garwin, Richard, 44–45 Fixed-income trading, Gastineau, Gary, 246–247 compared with equity trading, 10 Gatarek, model. See Brace-Gatarek- systems construction, object- Musiela model oriented unified framework. Gauss, Karl Friedrich, 1 See Goldman, Sachs and Co. Gedanken experiments, 268 bindex_derman.qxd 7/21/04 12:18 PM Page 280

280 INDEX

Geeks, characteristics, 11 Fixed Income Division, 120, 131 Geller, Uri, 63 Fixed Income Research, 169 Gell-Mann, Murray, 20–22, 25–26, 266. fixed-income trading systems See also Eightfold Way construction, object-oriented Totalitarian Principle, 40 unified framework, 115,177 Pais, enemy, 78–79 Information Technology, 185 General Motors (company), 41 intellectual diversity, tolerance, General Theory of Relativity, proposal 253 (Einstein), 2 IPO, impact, 253 Generative grammars, 112 Operations Finance & Resources Genesis (book), 13 (OF&R), 255–256 GER. See Guaranteed exchange rate partners, selection, 177 Ginsberg,Alan, 85 risk arbitrage group, 233 Glashow, Sheldon, 40, 46–47 Goldman, Sachs and Co., Financial standard model, 50 Strategies Group, 150–151 Glass-Steagall era, 187 arrival, 130 Gleick, James, 71, 73 model, testing, 159 GNMA, 192 politics, 137 Gödel, Escher, Bach (Hofstadter), 49 trouble, 176 Goeppert-Mayer, Maria, 23 Goldman, Sachs and Co., Quantitative Goethe, Johann Wolfgang von, 23, 72, Strategies Group, 14–15, 120, 270 140 influence, 73 equity volatility reports, 218 GoldC, usage, 141 growth, 218–219 Goldfield, Jacob, 131–132, 182–184 hardware, focus, 206 Goldman, Sachs and Co., 51, 99, 115 head, 136–137, 143, 176 approach. See Artificial intelligence interview, 203–204 Asset Management, 169 programs, number of times used, bond option model, 152–153 167 bonuses, 184–185 seminars, 169 cultural differences. See Salomon support for Structured Equity Brothers Products, 221 Derivatives Analysis group, 248, Goldman Sachs Asset Management 259–260, 262 (GSAM), 204 employees, number, 129 Good Earth,The, 87 employment, 11, 102 Gorky,Arshile, 73 enjoyment of life at, 118 Graduate Record Examination Equities Division, 140, 203–207 (GRE), 82 risk management system demon- Graduate student life, 29–30 stration, 219–220 Grammar. See Computer languages; Equity Derivatives, 255 Generative grammars exit, 124, 190, 254. 263 rules, 111–112 Firmwide Risk Division, 245, 248, Grand Unified Theories (GUTs), 265 255 Granovsky, Bob (Granny), 203–204, managers meeting, 262 212 VaR, 257–258 Nikkei put purchases, 210 bindex_derman.qxd 7/21/04 12:18 PM Page 281

INDEX 281

Grant,Toni,96 Heisenberg,Werner Karl, 2, 62 Gravitation HEQS. See Hierarchical EQuation laws (Newton), 1, 237 Solver theory (Einstein), 25 Herman, Ralph, 62 unified field theories, 25 Herman, Robert, 41–42, 100 Gravitational force, 35 Hershey, Roy, 89 Gray, Spalding, 96 Heuristic approximations, 27 Green, Mike, 44 Hierarchical EQuation Solver Greenberg,Ace, 184 (HEQS) Gregory,André, 118 collaboration, 126 Griswold, Dave, 140–141, 181–182 design/implementation, 113–114 Group games, 102 experience, 120 GSAM. See Goldman Sachs Asset modification, 115 Management High-energy phenomenology, 56 GS-ONE, 177 Higher worlds, knowledge, 85 work, completion, 184 Hilbert spaces, 265 Guaranteed exchange rate (GER), 221 Hilibrand, Larry, 189 option, 211–217 Hillel (sage), 260–261 valuation, 217 History in English Words (Barfield), value, 215 72–73 put, evaluation, 216 HJM. See Heath-Jarrow-Morton Gurdjieff, G.I., 73 Hofstadter, Douglas, 49, 62 Guth,Alan, 63 Hofstadter, Robert, 41–42, 46, 49, GUTs. See Grand Unified Theories 62 Hot zones, risk, 219 H Hull, John, 217, 238 Haghani,Victor, 176, 189, 195 award, 261 Harvard University, 144, 246 correspondence, 241 Haas School, 3 Hull-White (HW) model, 161 seminar, 106 Humboldt’s Gift (Bellow), 72 Hawking, Stephen, 57–58 Hutton. See E.F.Hutton Hawkins, Greg, 176, 189, 195 HW. See Hull-White model Headhunters, 119–120 Heath-Jarrow-Morton (HJM) model, I 161 IAFE. See International Association of Heaviside (indicator) functions, Financial Engineers algebra/calculus, 105 IBM Heavy neutral leptons, 62, 66 call options, 5–6 Hedge funds, 10, 110, 192 competition with AT&T, 108 Hedge ratio, in jump-diffusion option, creation, 7 models, 232–233 shares, 213 Hedging future prices, variation, 153 strategy, 211 Illinois Institute of Technology techniques. See Duration hedging (Chicago), 82–83 techniques Illiquid options, 260–261 interest rates, 122 Illiquid security, value, 261 bindex_derman.qxd 7/21/04 12:18 PM Page 282

282 INDEX

Implied binomial tree, 236, 237–238, Engineer of the Year. See Sungard 241 IAFE Engineer of the Year nodes, 240, 241 Financial Engineer of the Year, 171, Implied Binomial Trees (Rubinstein), 241 181, 261 Implied volatility, 239. See also Black- meeting, 241 Scholes implied volatilities; Interpolation, view of option models, Bonds 214–215 skew, 228 See also Smile Inverse-scattering problem, 237–238 two-dimensional implied volatility Investment banks, 110 surface, 228–229, 237 trading desks, 122 Indexlevels, response to. See IPOs. See Initial Public Offerings Volatility short-term volatility, 236 J Inelastic electron-proton scattering, Jack Kerouac School of Disembodied 46, 47, 58 Poetics, 85 Infinity, 179 Japanese interest rates, hedging, Information 258 freedom, 101 Jarrow, Robert theory, research, 100 award, 261 Ingersoll, Jr., Jonathan, 161 model. See Heath-Jarrow-Morton Initial Public Offerings (IPOs), 120, 175 model impact. See Goldman, Sachs and Co. textbook, 224 Inside the Yield Curve Jason Division. See Institute for (Homer/Liebowitz), 199 Defense Analysis Institute for Advanced Study, 42 Java (language), 106, 110 Institute for Defense Analysis, Jason Ji, Guru Maharaj, 86 Division, 44–45 Jobs, Steve, 140 Insurance companies, 192 Johnson, George, 78–79 Interest rates. See Short-term interest Jonas, Stan, 187 rates Journal of Finance, 223 distribution, 157–158 Joy, Bill, 108 grand unified theory, 159 J.P. Morgan, invention. See Value at increase (1990s), 91–92 Risk mean reversion, 162–163 J.P. Morgan Chase, 186 scenarios, 193, 196 Jump sensitivity, 133–134 movement, 231–232 Vasiçek model, 161 occurrence, 233 Interest Rates as Options (Black) ,173 reality of, 247 Interest rate-sensitive security, 159 Jump-diffusion model, 231–233 Interest-rate derivatives, 9 Juno (e-mail service), 108 Interest-rate options, sale, 133 Interest-rate risk, management, 122 K International Association of Financial Kaç, Mark, 34, 77, 237 Engineers (IAFE) method. See Differential equations educational syllabus, specification, theorem. See Feynman-Kaç 224 theorem bindex_derman.qxd 7/21/04 12:18 PM Page 283

INDEX 283

Kafka, Franz, 99 Kripke, Saul, 77 Kaluza,Theodor, 39 Kusch, Polykarp, 24, 62 Kaluza-Klein theories, 44, 70 Kamal, Mike, 189, 244 L Kandinsky,Vassily, 73 Lamb,Willis, 24 Kani, Iraj, 34, 165, 263 Lattice, of interest rates, 158 collaboration, 229–231, 234–240, Lattice computation diagrams, 69 243, 247–248 Law of one price. See One price Karasinski, Piotr, 206, 216 Lederman, Leon, 24, 35, 44, 62 formula for GER options, 212, 215 Columbia experiment, 50 formula, 215 Lee,Tsung-Dao, 24–26, 28, 32, 35–37, model. See Black-Karasinski model 40, 61–62 Karma, 91, 118 audience, at seminar and thesis Kegeles, Larry, 103–106 defence, 50 Kender, John, 108–109 framework, usage. See Parity Kepler, Johannes, 38 intellectual attack by, 75 laws. See Planetary motion profile, 80 Kernighan, Brian, 100, 108 Yang, feud with, 79 Kerouac, Jack. See Jack Kerouac Lee model, 56 School of Disembodied Poets Lehman Brothers, merger, 179 Kingdom of Denmark Leibniz, Gottfried Wilhelm, 2453 GER option, partial differential Leibowitz, Marty, 121, 187, 199, equation (derivation), 212 201–202 Nikkei put warrants, 209–212, Lepton, decay. See Heavy lepton 215–217, 218–219 Levy, Gus, 196 risk factors, 214 Lex (computer tool), 112 Klaffky,Tom,187–190, 201 Libchard (chaos investigator), 73 Klebb, Rosa, 207 Light Kleene, Stephen, 112 propagation, 1 Klein, Oskar, 39, 70 wavelengths, correction, 23 theories. See Kaluza-Klein theories Linear algebraic equations, 113 Klein-Gordon equation, 70 Lisp (language), 106 Klein-Nishina formula. See Compton usage, 140 scattering: Photon-electron Lisp (Symbolics computer), 141 scattering Litterman, Bob, 184 Knowledge of the Higher Worlds Litzenberger, Bob, 255 (Steiner), 44, 72, 88 Local gauge invariance, symmetry Knuth, Donald, 114 principle (Yang), 46 Koenigsberg, Mark, 93, 97, 103–106, Local volatility, 236, 239–241 117, 199–200 impact. See Black-Scholes options employment, 127, 188 pricing model Kopprasch, Bob, 127, 176 model. See Implied binomial tree, options research group, 187 Smile Korn,David, 118 Logdberg, Linda, 29 Kovalevskaya, Sonya, 78 Long Term Capital Management Krasker, Bill, 189, 195 (LTCM), 144, 176, 246 bindex_derman.qxd 7/21/04 12:18 PM Page 284

284 INDEX

Long Term Capital Management, Mathematical Theory of Communication, continued A (Shannon), 100 bail-out, 13 MathematicaTM, usage, 48, 66, 115 decapitation/collapse, 109, 138 MatlabTM, usage, 66 Long-dated bonds, long-expiration Mattu, Ravi, 200 options on, 154–155 Maxwell, James Clerk, 1 Long-term barrier options, hedging equations, 22, 268–269 gold production with, 259 law. See Electromagnetism Long-term yields, viewed as average theory, 46 of short-term rates, 234 Mayer, Joseph, 23 Lorentz, Hendrik Antoon, 33–34 McAdams, Harley, 93, 97–99, 101 Lotus, usage, 113, 219 McCarty, Maclyn, 77 Louw, Jannie, 43–44, 72 McNamara, Robert S., 80 Lowenstein, Roger, 97 Mechanics LTCM. See Long Term Capital laws (Newton), 33 Management understanding, 38 Meditation, 88–90, 98 M Members of Technical Staff. See Bell MacLeod, J.J.R., 77 Laboratories Makeveyev, Dusan, 104 Mendeleyev, Dmitri Ivanovich, 19 Malle, Louis, 117–118 Meriwether, John, 97, 144 Managing Traders (Black), 171 arb group, 176, 189–190, 195 Mandarins, 77 Merrill Lynch, 252 Manhattan Project, 23, 63 Merton, Robert, 101, 144, 154 Mann,Al, 58 award, 261 Man’s Search for Meaning (Frankl), meeting, 246 44 replication method, 145–146, 170 Many-worlds values, 260 Microsoft, share (value), 258 Margrabe, Bill, 213–214 Microwave radiation, 41 Marino, Jory, 119 Middleman, between traders and Market crashes, 10 quants, 166 Market data, 165–166 Millikan, R.A., 22 Markiewicz, Ed, 177, 184, 190 Mills, gauge theories. See Weak/ Marking to market, 258 electromagnetic interactions Markman, Steve, 119 Milne,A.A., 209, 220 Markowitz, Harry M., 171 Mocatta Metals, 252 Marriage of Heaven and Hell,The Models, See also Black-Derman-Toy (Blake), 269 model, Implied binomial tree, Marsh,Terrry, 105 Local volatility models Massachusetts Institute of Technology building,Watson/Crick approach, (MIT), 3, 63, 93 186 Black archived files, 150 improvement, 143 professors, 5, 144, 147 pragmatism, 266 Mathematical analysis, 9 variables, 269 Mathematical beauty, 27–28 Mondrian, Piet, 73 Mathematical formalism, 111 Monte Carlo computer programs, 66 bindex_derman.qxd 7/21/04 12:18 PM Page 285

INDEX 285

Monte Carlo simulations, 265 permutation symmetry, 73 model, output, 193 reflection-invariant forces, 35 program, construction, 170 Totalitarian Principle, Gell-Mann’s, Morgan Stanley, 154, 252 40 pairs trading, 109 Ne’eman,Yuval, 20, 22 Mortgage portfolio valuation system. Network Systems. See Bell See Bear Stearns Laboratories Mortgages Neural-net theory, 26 complications, 193 Neutral heavy lepton, 60 lifespan, 192 Neutrino. See also Muon-type modeling, 193–194 neutrinos sale, 121 production, 59–60 securitized pools, 176 discovery, 24 valuation models, 193 existence, 23 Morton, model. See Heath-Jarrow- Neutrino Conference, 63, 67 Morton model New York Cryonics Society, 41 Morton Thiokol, puts, 139 New York,life in, 31–32 Motion, laws (Newton), 1 New York Road Runners Club, 81 Mt. Sinai Medical School, 127 New York Stock Exchange (NYSE), MTS. See Bell Laboratories 225 Muons New York University, 3 production, 59–60 Newton, Isaac, 1 distribution. See Dimuons emulation, 27 events. See Dimuons laws. See Gravitation; Mechanics; particle, 39–40 Motion similarity. See Electrons obeying, 13 speed, 61–62 solving, 12 Muon-type neutrinos, 58 Newtonian observer, 268–269 Musiela, model. See Brace-Gatarek- Next (computer), 140 Musiela model Ng, John, 60–62, 66 Mutual funds, 192 Nikkei My Dinner with André (Malle), 225 index, 209–212, 225 117–118 book, hedging, 212 Mystic Path to Cosmic Power,The, 90 futures, 216, 219 hedge, 216 N insurance, selling, 217 Nabokov,Vladimir, 31 level, impact of change in, 219 Nanocomputers, 14 options, 212 Naropa Institute, 85 low-strike puts, 227 Natural constants, values, 82 prices, asymmetry of, 225 Natural languages, expression, puts, 218–219 111–112 Nkomo, Joshua, 69 Nature Non-linear algebraic equations, 113 asymmetry, 36 Non-procedural programs, 112 knowledge, 270 NonVon (computer), plan for, by laws, description, 74 David Shaw 109 bindex_derman.qxd 7/21/04 12:18 PM Page 286

286 INDEX

Nuclear physics, understanding, 38 Orange County, derivatives scandals, Nuclear weak decays, parity violation, 182 36 O’Rourke, Dan, 211–212, 219–220, Nuclei, radioactive disintegration, 35 251, 263 Number theory, problem/solution, OTC. See Over-the-counter 32 OTÖB conference, 245–246 NYSE. See New York Stock Out-of-the-money calls, 259 Exchange Out-of-the-money puts, 226, 228, 259. prices, 225 O Over-the-counter (OTC) call OAS. See Option-adjusted spread options, 133 Objective C, usage, 140 Over-the-counter (OTC) volatility Object-oriented language, writing, swaps, 189 140–141 Overtime hours, at Bell Laboratories, Object-oriented programming 103 (OOP), 118 Oxbridge, emulation by Rockefeller O’Connor & Co., 120, 178, 180–181 University, 78–79 Oil crisis (1970s), 91–92 Oxford University Omega Minus (Gell-Mann), 20, 26 Department of Theoretical Physics, discovery, 22 65–69 One price, law of, 154, 159, 261 postdoctoral study, 28, 61 One-Factor Model of Interest Rates and Its Application to Treasury Bond P Options,A, (Black, Derman, Pagels, Heinz, 79–80 Toy) 160 Paine Webber, 252 OOP. See Object-oriented Pais,Abraham (“Bram”), 37, 61, 66, programming 75, 81 Operations Finance & Resources enemy. See Gell-Mann (OF&R). See Goldman, Palgrave Dictionary of Economics, 5 Sachs and Co. Palm Pilots, 109 Oppenheimer, Robert, 22, 63 Parallel-processing computer, Option-adjusted spread (OAS), 196, See NonVon 199 Parapraxis, See Fehlleistung Options. See Stock options Paribas Capital Markets, 238 exotic, 221–222 Parity, law of, 24, 35, 47, 50 creation of model, 7 Parity-violating weak force, 47, 74 implied volatility, 226, 227 Parsing tools, 112 prices, quoting, 234 Partial differential equations, 265 pricing Particle physics, 26. See also Black-Scholes model, 5 Elementary particle physics risk system, 179 summer school. See Ettore valuation, method, 214–215 Majorana Options theory symmetry in, 35 differential equations, solution, 34 thesis advisor, search, 42 history, 144–147 Particles. See Fractional charge particle learning, 135 detectors, construction, 30 bindex_derman.qxd 7/21/04 12:18 PM Page 287

INDEX 287

string theory model, 44 Preprint, circulation, 61, 68 proliferation, 19–20 Prescott, Charles, 50 Partons, 46 Presentation style, Black, 148–149 model description. See Protons Price to earnings (P/E) ratio, 213 P/E. See Price to earnings Princeton University, 42, 61 Peierls, Rudolf, 78 Privacy, invasion of, 102 Pencom (company), 119 Probability cloud, 231 Penzias,Arno, 41 Procedural languages, 113 Periodic table Procedural programs. See Non- construction (Gell-Mann/Ne’eman), procedural programs 20 Proctor and Gamble, derivatives construction (Mendeleyev), 19, 46–47 scandals, 182 Permutation symmetry. See Nature Profit and loss (P&L), 221 extension, 74 Programming: Practice and Experience, 115 Phenomenological models, 160 Programming (activity), 106 Phenomenology, 27–28. See also Prometheus Project,The 41 High-energy phenomenology Protons Photon-electron scattering, Klein- internal structure, investigation, Nishina formula, 70 41–42 Physical Review Letters, 76 parton-model description Physicists. See Theoretical physicists (Feynman), 47 employment. See Wall Street Publish or perish, experience of, 56 Physicists on Wall Street (POWs), 5 Pure theory, 27 Physics. See Fundamental physics competitiveness, 56 Q discoveries, difficulty of, 63–64 QED. See Quantum electrodynamics education, 65 Quals. See Columbia University finance, relationship, 1 Quantal (financial software company), intuition, role of, 48 105 pursuit (sacred/profane), 13–15 Quantitative Strategies Group. See summer institute. See Stanford Goldman, Sachs and Co. Linear Accelerator Center Quantitative Strategies Research Pinkus, Scott, 254 Reports, 216 P&L. See Profit and loss Quanto option, 211 Planck, Max, 2 Quants Planetary motion, laws (Kepler), 38 contrast. See Traders Plauger, P.J., 108 discontent, 254 Political correctness, 102 envy, 125 before the time of, 54 history, 8 Polypaths (company, Diller), 124 life, 8–10 Post-Black-Scholes model, con- thinking process, 12 struction, 234 Quantum electrodynamics (QED), 23 Postdoctoral research positions, 55–56 derivations (Feynman/Schwinger), POWs. See Physicists on Wall Street 146 Prepayment rates, regression model. lectures, 24–25 See Adjustable Rate Mortgage renormalizability (Feynman), 74 bindex_derman.qxd 7/21/04 12:18 PM Page 288

288 INDEX

Quantum mechanics, 2, 21, 34, 38 Rubin, Bob, 99, 131, 132, 147, 177, Quarks. See Charmed quark 183 discovery, 26 Rubinstein, Mark, 235, 238, 241 existence, 45 address, 243 Quotron, (device) 199 award, 261 textbooks, 141–142, 224 R Rudd, textbook, 224 Rabi, I.I., 22, 37 Ruderman, Malvin, 44–45 Ranieri, Lew, 176–177 Russia, default (1998), 138 Raz, Rita, 119 Rutherford Laboratories, 75 Reductionists, 26, 27, 71 Reflection-invariant forces. S See Nature Shopiro, Jonathan, 118 Reich,Wilhelm, 104 Salam,Abdus, 46–47 Relativity, theory. See Special relativity model. See Weinberg-Salam Renaissance, 179 standard model Replication method. See Merton standard model, 50 convergence. See Black-Scholes Salomon Brothers, 97 value bad days, 191 Risk (magazine), 154, 238, 243 contribution, 188 Risk management, 10 employment, 103–104 software, 178 Fixed Income Division, 121 systems, construction/elaboration, Goldman, cultural differences, 237–238 195–196 tools layoffs, 200–201 construction, 122–123 OAS concept, 196, 199 Risk Management System (RMS) take-no-prisoners culture, 194 (company), 178–179, 180, 187 transfer to, 188–189 Risk systems Salthouse,Andy, 99–100 Samurai, construction of, Samuelson, Paul, 213 219–220 Samurai (trading system) 219–221 enhancement, 233 Scheinkman, José, 184 Risk/return, relationship, 12 Schlumberger, 92 Risky ingredient, specification. oil retrieval mathematics, 4 See Options Scholes, Myron, 144 Ritchie, Dennis, 100, 106–108 options pricing model. See Black- RMS. See Risk Management System Scholes options pricing model Rockefeller Foundation, 17 Schopenhauer,Arthur, 92–93 Rockefeller University, 24–25, 37, 75, Schrieffer, Bob, 63 77, 91, 95 Schrödinger, Erwin, 2 Rogers, Dave, 225, 227, 237–238 Schwartz, Mel, 24, 35 Roll & Ross Asset Management, 193 Schwenk, Peter, 73 Roscoe. See Dumas Schwinger, Julian, 23–24, 37, 112 Ross, Stephen A., 5, 161, 193, 235 derivations. See Quantum electro- award, 261 dynamics Rouhani, Ramine, 185–186 Securities Industry Association, 180 bindex_derman.qxd 7/21/04 12:18 PM Page 289

INDEX 289

Security. See Derivative security Smalltalk (computer language), usage, fair value, 12 140, 182 SERI. See Solar Energy Research Smile. See Equity options;Volatility Institute phenomenon, models of, 227–233 Seymour (object-oriented language), local volatility, as explanation, 182 246–247 Shakespeare and Co. (bookstore), 96 Smith, Chris Llewellyn, 67, 71, 75 Shannon, Claude, 100 Smith Barney (company), 252 Shapiro, Lucy, 93 Smith Hanley (company), 119 Sharaf, Myron, 104 Solar Energy Research Institute Sharpe,William, 235 (SERI), 4, 92 Shaw, David, 108–109. See also D.E. Songs of Innocence and Experience Shaw & Co. (Blake), 71 secrecy, 110 S&P. See Standard & Poor’s Shaw & Co., D.E., 13 Special relativity, theory (Einstein), 2, Shawn,Wallace, 118 33, 39 Shearson Squalid-state physics (solid-state acquisition, 179 physics) 26–27 bureaucracy, depth, 187 Standard & Poor’s (S&P) 500, 258 Sheppard, Ed, 114–115 index, 222–223 Sherman, Ron, 98 option, hedging, 248 Shockley,William B., 100 Stanford Linear Accelerator Center Shorter, Frank, 85 (SLAC), 46, 50, 56, 62, 68, 73 Short-term bonds, 157 Stanford Research Institute, 63 options, approximation, 152 Steambath (Bruce Jay Friedman), 119 Short-term interest rates, 134 Steinberger, Jack, 24, 35, 62 distribution, 161–162 Steiner, Rudolf, 44, 72, 88 Short-term options, expiration, 152 influence, 73 Short-term problems, 92 theories. See Education Short-term volatilities, 234. See also views, 73 Index, Local volatility Stochastic calculus, 146, 163 in local volatility model, 235 Stock options, 12 Showers, Janet, 187–188 Black-Scholes model, 134 Siegel, Mo, 86 usage, 146–147 Sigma (), 229–232 Stock prices Silfen, David, 220 diffusion, 231 Simon Fraser University, 246 distribution, 151 Simultaneous algebraic equations, 113 Stocks Sin, mechanical expiation of, 91 trading, 120–121 Sinclair, Don, 69 volatility, 229 Sitzfleisch, 26 Stop-time, 117 Skew, 225 See also Smile Stormer, Horst, 100 Skidelsky, Robert, 15 Strachey, James, 72 SLAC. See Stanford Linear Accelerator String theory, 44 Center Structured Equity Products business, Sloan School, 3 221 bindex_derman.qxd 7/21/04 12:18 PM Page 290

290 INDEX

Strunk, Jr.,William, 108 Thompson, Ken, 106–108 Subnuclear particles, 26 Tibetan Buddhism, 85, 88 Sun UNIX workstations, 179 TOEs. See Theories of Everything SunGard (financial software com- Tolstory, Leo, 91 pany), 5 Tomonaga, Shin’ichiro, 23–24 SunGard IAFE Financial Engineer Totalitarian Principle. See Gell-Mann of the Year, 181 Tour de France, 12 Swaps. See Volatility Toward a Fully Automated Exchange valuation, 176, 189–190 (Black), 206 Swiss Bank, merger with UBS, Toy, Bill, 101, 139–141, 155–156, 162, 180–181 203, 204, Swiss watch collisions, 59 Black joke, 149 Symbolics. See Lisp collaboration, 154 Symmetry. 35 See also Particle commiseration, 185–186 physics, Local gauge Traders invariance, Parity, Nature quants, contrast, 11–12 Szüts, Eté, 31, 32 thinking process, 12 transactions, handling, 252 T Trailing zeros, removal, 149 Tachyons, 40 Transformer, 129 Tao of Physics,The (Capra), 183 Translation process, 110–112 Tar taglia, Nunzio, 109 Trees. See Binomial trees; Flexible tree Tatevossian,Armand, 199–200 calibration. See Yield curve Tau-theta puzzle, 36 construction, 158–159 Taylor, Richard, 50 variable periods, incorporation. T.D. See Lee See Black-Karasinski model TIAA-CREF 202 Treiman, Sam, 61, 66 Technology bubble, 223 Treynor, Jack, 172 Teller, Edward, 63 Trungpa, Chogyam, 85, 88, 104 Tests for a Weak Neutral Current Tu c ker:The Man and His Dreams (Derman), 50 (Coppola), 180 TeX (computer language), 114 Tur ing,Alan, 112 Theoretical particle physics, 27, 47, 68 Two-condom problem, 104 employment, 83 Theories, success, 5–8 U Theories of Everything (TOEs), 265 Uberoi, J.P.S., 270 Theory, exploration/refutation, rela- UBS, merger, 180–181 tion to phenomenology 27–28 Understanding Guaranteed Exchange- Theory of Colours (Goethe), 270 Rate Options (Derman, Theory of Electrons (Lorentz), 33 Karasinski,Wecker), 216 Theory of Rational Optional Pricing Unified field theories, 75 (Merton), 101 Universe, laws (pursuit), 15 Theosophists, 73 University of Cape Town, 32 Thermodynamics, understanding, 38 physics department, 18–19 Thinkers, doers (contrast), 11–13 poems with punched cards, usage, 106 Thinktank (computer program), 150 thesis, 39 bindex_derman.qxd 7/21/04 12:18 PM Page 291

INDEX 291

University of Chicago, 23, 41, 146 impact, 4 University of Colorado protests, 44–45 loneliness, 83, 86–88 Visicalc, usage, 113 University of Coral Gables, 82 Volatility, 219. See also Local volatility; University of Michigan (Ann Arbor), Short-term volatilities 3 calculation, 165–166. See also Yield University of Wisconsin (Madison), 61 local, illumination of, 240–241 University of Oregon, 3, 49 index levels, response to, 238–239 University of Pennsylvania, 51, 54–56, smile, 225–226, 248 63, 103 surface, 236 University of Toronto, 217 swaps, 189 UNIX, 11 von Neumann, John, 109 operating system, 110, 112 VT-100 terminal emulator, 148 philosophy, 136 portable versions, 106 W programming environment, Waldmann, Mike (mortgage research 107–108 group), 187, 190–192, 198, software development, 127 200–201 style, 140 Wall Street tools, 112, 114, 180 “brutality,” 135 usage, 107, 141 modeling needs, 120 workstations. See Sun UNIX physicists, employment, 4 workstations Wastrom, Rick, 119 U.S.Treasury bonds Watson Labs, 125–126 futures contracts, embedded Weak force, 35, 36, 61. See also Parity- delivery option valuation, 184 violating weak force inclusion. See Investment portfolios electromagnetic force, similarity, 46, interest payment, 153–154 47 options business, increase, 132 existence, 47 value, decrease, 121–122 theory (Fermi), 46 Weak interactions. See Parity-violating V weak interaction Value at Risk (VaR), 256–257 analysis, 61 concentration. See Goldman, Sachs theory, 60, 63 and Co. Weak neutral current, 47 J.P. Morgan invention, 256 Weak/electromagnetic interactions, Van Wyk, Chris, 114–115 Yang-Mills gauge theories, 57 Va nya on Forty-Second Street (Malle), Wecker, Jeff, 203–206, 216 118 Weinberg, David, 120 VaR. See Value at Risk Weinberg, Steven, 40, 46–47 Vasiçek, Oldrich, 161 standard model, 50 VAX (computer), usage, 120, 135, Weinberg-Salam standard model, 47 147–148 Weingarten, Don, 125–126 Velvet Revolution, 254 Weiss, Larry, 184 Vienna options exchange, 243 Weisskopf,Victor, 63 Vietnam War Weizmann Institute, 69 bindex_derman.qxd 7/21/04 12:18 PM Page 292

292 INDEX

Wells Fargo, 138 reputation, 38 Western Electric, 98 symmetry principle. See Local When Genius Failed (Lowenstein), 97 gauge invariance White, E.B., 108 Yet Another Compiler-Compiler White, model. See Hull-White model (Yacc), 112 Wilczek, Frank, 52 Yield Williams College, 103 diffusion model, 234 Wilmott, Paul, 267 tables, book, 122 Wilmott on Derivatives (Wilmott), 267 viewed as an average. See Long- Wilson, Robert, 41 term yields Wind in the Willows (Milne),The, 38 volatility/uncertainty, calculation, Wolfram, Stephen, 71 157–158 Wolfram Research, 72 Yield curve World Trade Center, attack, 262–263 movement, 155, 193, 265 World War II, 3 modeling, 162 W.R.: Mysteries of the Organism short-term rates, 163 (Makeveyev), 104 tree, calibration, 162–163 Wu, Chien-Shiung, 35–36, 74 Yield to maturity, 199 recommendation, 54 Yiu, Chang-Li, 49–50 Y2K, anxiety, 107 X Yom Kippur, 45 Xerox PARC inventions, 140 Young Investigator Award in High X-rays, propagation, 1 Energy Physics Research. See Department of Energy Y Yacc. See Yet Another Compiler- Z Compiler Zero-coupon bonds, collection, Yang, Chen-Ning, 24, 35–37 153–154 feud. See Lee Zero-coupon Treasury Strips, gauge theories. See Weak/electro- creation, 187 magnetic interactions Zou, Joe, 189, 244 profile, 80 Zuckerberg, Roy 220