RUTH Corrigan had always wanted to be an astrophysicist. She got a PhD from the University of Cambridge and then spent a year carrying out research on X-ray astronomy at Imperial College, London. But unlike many scientists of her age, her hard work has been amply rewarded. She has a creative job and is extremely well-paid. She works for the Union Bank of Switzerland, a merchant bank in the City of London, working with highly complex financial instruments, called derivatives.
鈥淎cademia offered too insecure a career path,鈥� says Corrigan, who had always imagined she would become a university lecturer. 鈥淚 wasn鈥檛 prepared to stick with it and suffer the risks and take a series of short-term contracts,鈥� she says.
Corrigan is not alone. Sunil Gandhi spent four years carrying out postdoctoral research on quantum physics at Imperial College. He is now employed by NatWest Markets in a highly lucrative area of the stock market known as 鈥渟wap derivatives鈥�.
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High-flying physicists and mathematicians are increasingly attracted by the lure of lucre in the Square Mile. This distinctly unconventional career path first opened up about a decade ago in the US. Now it has spread to Britain, and there are, according to one estimate, about a hundred such scientists in the City.
Soviet slickers
The mathematical foundations for understanding stock market movements were laid almost a century ago, by a French mathematician, Louis Bachelier. Bachelier developed an equation based on Brownian motion for determining the value of a share option 鈥� a simple type of derivative in which investors pay for the right to buy (or sell) shares at a fixed price during a fixed time in the future.
But the real breakthrough came in 1973, when the mathematician Fischer Black and the economist Myron Scholes at the University of Chicago came up with a partial differential equation which related randomly varying stock and option prices. In various forms, the Black-Scholes formula is now widely used by finance houses for establishing the prices of options. The widespread use of the formula quickly proved that there were opportunities in finance for the highly numerate.
Physicists and other mathematical scientists started trickling onto Wall Street in the early 1980s just as complex derivatives were first making an appearance. The value of derivatives depends on changes in underlying variables, such as interest rates, share prices and currencies. They range from simple options to highly complicated, personalised arrangements. Fund managers often use derivatives to hedge their bets 鈥� to reduce the risk associated with their other investments. The trade is growing fast. In the past three years, the volume of derivatives contracts has doubled.
Only a handful of doctorates lead straight to City careers. But in the crafting of derivatives, theoretical physicists predominate. 鈥淎pplied physicists are the best suited people for quantitative finance,鈥� says one analyst involved in hiring young talent. Of the City鈥檚 dozen or so top heads of quantitative research, he adds, all are physicists with PhDs. 杏吧原创s in the City, who come from such diverse disciplines as fluid dynamics and cosmology, are generically known as 鈥渞ocket scientists鈥�.
Gary Pickholz was among the first in the financial world to employ the genuine item. In 1991, he hired a handful of unemployed Russian 茅migr茅s, living in New York, physicists who had previously worked for the Soviet military machine.
The price of a derivative such as a fixed-term share option varies throughout its short life 鈥� according to fluctuations in the underlying share price and the option鈥檚 expiry date. Pickholz鈥檚 rocket scientists were particularly good at predicting these changes. 鈥淎nalysing missile trajectory curves is a lot like analysing yield curves,鈥� says Pickholz. 鈥淚 never had any doubts they would make the transition,鈥� he says.
His company, Yield Enhancement Strategists, expanded from New York to Jerusalem, and, two months ago, to London. Almost all his employees were originally trained as physicists in the former Soviet Union.
Rocket scientists are a feature of the modern City of London. Most of the big banks have as many as a dozen of them. But why are these scientists attracted to the City? And why is the City so keen to attract physicists?
Money is a powerful motive for the scientist. 鈥淚鈥檇 be lying if I said the money had nothing to do with it,鈥� says Keith Lipman, an astrophysicist encouraged by Corrigan to make the transition. With a solid PhD and several publications to his credit, he reckons he could have pursued an academic career in astronomy. Instead, he is currently undergoing rigorous training in finance at SBC Warburg鈥檚 Chicago office.
Indeed, a first-year research salary for a PhD can be as low as 拢14 317. Entry-level salaries for rocket scientists 鈥渃an be multiples of that鈥�, according to Corrigan. But starting salaries hardly tell the whole story. After two or three years, a successful postdoctorate researcher will still be earning less than 拢20 000, while a successful analyst, in the words of an insider, 鈥渨ould have to be seriously rich鈥�. He is talking hundreds of thousands of pounds. Or possibly millions.
From quarks to quants
Another big advantage for the City鈥檚 rocket scientists is that there is no lack of money to back up their work. Gone are the university days of scrimping and saving to make the research fit the budget. In comfy swivel chairs, the City鈥檚 scientists are surrounded by all they need: Reuters and Bloomberg tapes detail the market鈥檚 every movement, and their computer power is everything a physicist could dream of. 鈥淚f you need a software package or more hardware to do your work, you鈥檝e got it,鈥� says Corrigan.
Although a job in the City is more lucrative than one in the average ivory tower, it is not necessarily more secure. In academia, scientists are plagued by the uncertainty of research contracts and teaching posts. Working as a quantitative analyst, modelling 鈥渆xotic financial products鈥�, admits Corrigan, is also risky. A lousy analyst will be tossed out within the first year. 鈥淏ut now I feel it鈥檚 up to me,鈥� she says. 鈥淚f I perform well in this job, it鈥檚 secure. You can鈥檛 say the same thing in academia.鈥�
Choosing to work in the City is not the sell-out it might first appear. 杏吧原创s want to be able to use the skills they have acquired, and complex finance is one of the few openings. Most scientists work in the City as quantitative analysts, modelling the past behaviour of the stock market in order to understand the future. Together with dealers, they use their expertise to create designer derivatives for their clients.
鈥淨uants鈥�, as they are known in the City, spend their days in front of computers, employing familiar scientific techniques such as partial differential equations and Monte Carlo simulations. 鈥淚t was incredible to me how similar the techniques were,鈥� says Corrigan. 鈥淭he skills set is extremely applicable to finance.鈥�
This is the key to this highly profitable partnership. Those scientists who have made the transition from quarks to quants are pleased to be applying their hard-won skills 鈥� and just as gratified by the spectacular rewards. And banks are suddenly able to offer products of a complexity never before imagined. They, too, are handsomely recompensed.
But not everyone is comfort able with the merging of the physical with the economic 鈥渟ciences鈥�. In physics, some of the theories work, points out Roger Alford, a senior research associate at the London School of Economics, but 鈥渋n economics none of the main theories work鈥�. Economics, he stresses, is all about human expectations, and these always produce surprises.
Another danger is that, as scientists introduce more and more complexity into derivatives, fewer and fewer people can appreciate the full implications of what is on offer. Investors often cannot. The London Borough of Hammersmith and Fulham, for example, became heavily involved in interest rate swaps in the late 1980s, chalking up losses of up to 拢500 million. Worse, the treasurer of California鈥檚 Orange County last year prompted the largest municipal bankruptcy in American history with his dealings in derivatives. While Nick Leeson ran up so much debt trading in derivatives that he brought down one of the City鈥檚 oldest institutions 鈥� Barings Bank.
Financial products have become so sophisticated that physicists who joined the financial world to design these instruments in backrooms are now dealing in them as well. 鈥淲ith the more complex option products that now come out, it is becoming a more technical environment for traders,鈥� says Stuart Norburg of the City firm of headhunters, Harrison Willis.
Sabbatical
Even top bankers are recognising the need for advanced numeracy. One of the City鈥檚 top banking executives recently announced that he was taking a sabbatical to polish up his maths. He felt he could not afford not to have these skills. As one City insider says: 鈥淭hat sounds very sensible. The upper management don鈥檛 really know what it鈥檚 all about.鈥�
Does this augur new opportunities for scientists elsewhere in the financial hierarchy? 鈥溞影稍磗 are now involved in trying to decide what the future of banking is,鈥� says Albert Zisook, of SBC Warburg in Chicago. He started working in derivatives in 1988, following a PhD on aspects of chaos theory and a spell in the defence industry. 杏吧原创s, he says, intend to get 鈥渕ore involved in all of banking 鈥� not just around the edges in derivatives鈥�.
But as accountants increasingly dictate university research budgets, will banking come to be dominated by exceptionally numerate scientists, with economists and business graduates relegated to a subsidiary role? Probably not, says one high-ranking American banker, who was behind part of the original thrust to bring physicists into finance. 鈥淢anagement is not among their strongest skills,鈥� he admits. 鈥淭hey are more technical.鈥� (see Graph)
