Quantitative analysis (finance)

Quantitative analysis in finance refers to the application of mathematical and statistical methods to problems in financial markets and investment management. Professionals in this field are known as quantitative analysts or quants.

Quants typically specialize in areas such as derivative structuring and pricing, risk management, portfolio management, and other finance-related activities. The role is analogous to that of specialists in industrial mathematics working in non-financial industries.

Quantitative analysis often involves examining large datasets to identify patterns, such as correlations among liquid assets or price dynamics, including strategies based on trend following or mean reversion.

Although the original quantitative analysts were "sell side quants" from market maker firms, concerned with derivatives pricing and risk management, the meaning of the term has expanded over time to include those individuals involved in almost any application of mathematical finance, including the buy side. Applied quantitative analysis is commonly associated with quantitative investment management which includes a variety of methods such as statistical arbitrage, algorithmic trading and electronic trading.

Some of the larger investment managers using quantitative analysis include Renaissance Technologies, D. E. Shaw & Co., and AQR Capital Management.

Quantitative finance started in 1900 with Louis Bachelier's doctoral thesis "Theory of Speculation", which provided a model to price options under a normal distribution. Jules Regnault had posited already in 1863 that stock prices can be modelled as a random walk, suggesting "in a more literary form, the conceptual setting for the application of probability to stockmarket operations". It was, however, only in the years 1960-1970 that the "merit of [these] was recognized" as options pricing theory was developed.

Harry Markowitz's 1952 doctoral thesis "Portfolio Selection" and its published version was one of the first efforts in economics journals to formally adapt mathematical concepts to finance (mathematics was until then confined to specialized economics journals). Markowitz formalized a notion of mean return and covariances for common stocks which allowed him to quantify the concept of "diversification" in a market. He showed how to compute the mean return and variance for a given portfolio and argued that investors should hold only those portfolios whose variance is minimal among all portfolios with a given mean return. Thus, although the language of finance now involves Itô calculus, management of risk in a quantifiable manner underlies much of the modern theory.

Modern quantitative investment management was first introduced from the research of Edward Thorp, a mathematics professor at New Mexico State University (1961–1965) and University of California, Irvine (1965–1977). Considered the "Father of Quantitative Investing", Thorp sought to predict and simulate blackjack, a card-game he played in Las Vegas casinos. He was able to create a system, known broadly as card counting, which used probability theory and statistical analysis to successfully win blackjack games. His research was subsequently used during the 1980s and 1990s by investment management firms seeking to generate systematic and consistent returns in the U.S. stock market. The field has grown to incorporate numerous approaches and techniques; see Outline of finance § Quantitative investing, Post-modern portfolio theory, Financial economics § Portfolio theory.