Statistical Arbitrage

FEN One on One Interview: Emanuel Derman

FEN: If you were starting out in quantitative finance now, what area would you find the most challenging?

Derman: Not derivatives at this point, although it would be the easiest segue from physics. If I were still doing research or coming in new to the field, I’d find statistical arbitrage interesting. It’s about market microstructure, about trying to understand how prices actually get determined. In derivatives you assume the existence of prices before you start. Then you calculate the option price from the stock price. It’s a relative problem. In contrast, the stat-arb people have to be concerned at bottom with how stock prices come into existence. They have to understand the price cross-sectionally, by comparing the price of one stock with the price of another stock, and longitudinally, in the time direction, by comparing a company’s stock price today with its stock price yesterday. So, for instance, is IBM cheap relative to Sun Microsystems, or is IBM cheap today relative to IBM’s stock price yesterday? That seems like a theoretically interesting and still unsolved problem to me.