Making the Quantitative Models Work

By Michael Feldman

October 2, 2008

The ongoing financial turmoil in the U.S. continues to flog the stock market and the credit market. Not surprisingly, economists are in disarray, predicting everything from a mild recession to the end of capitalism. What is more widely agreed upon is the root cause: the bursting of the housing bubble and the related sub-prime and adjustable rate mortgages that banks and investment firms have been accumulating and trading like baseball cards.

As I wrote last week, the quantitative models used to value these mortgages (in the form of collateralized debt obligations or CDOs) were probably suspect or, at the very least, were being misused. Digging a little deeper, it appears that this was the case across the spectrum of buyers, sellers and rating agencies throughout the investment community.

The problems with the CDO models have been known for some time. In a Wall Street & Technology article from September 2007, Penny Crosman begins thusly: “Why didn’t the sophisticated, computerized pricing models that Wall Street firms use to predict returns and risk for complex derivatives save them from the sub-prime mortgage mess? The short answer is: Fund and portfolio managers rarely use them.” Crosman goes on to reveal some problems with the algorithms themselves, noting that “some models for analyzing mortgage-backed securities don’t include house prices, which are a fairly important piece of the puzzle.” In other cases, the models were simplified for the sake of expediency. One quant noted that “[t]raders will like a light model because they don’t need heavy routines that will take forever to run on their machines.”

A lot of the problem started with the rating agencies at places like Standard and Poor’s (S&P), Moody’s and Fitch. In a recent article by Elliot Blair Smith in Bloomberg News, the author makes the case that the agencies mismanaged the models. Frank Raiter, a former director of S&P’s business unit that rated residential mortgages, tried to urge management to “develop more sophisticated financial models and buy more detailed loan data for monitoring securities the company graded.”

But as long as real estate prices kept rising, there was little incentive for either the rating agencies or their customers to make the ratings more robust. Everyone profited by keeping the party going.

Smith lays some of blame on the quantitative models themselves, noting: “AAA ratings on sub-prime mortgage investments can be traced to the rise on Wall Street of quantitative analysts, or quants, with advanced degrees in math, physics and statistics. They developed computer-driven models that didn’t rely on historical performance data, according to Raiter and others. If the old rating methods were like Rembrandt’s portraiture, with details painted in, the new ones were Monet impressionism, with only a suggestion of the full picture.”

In truth, though, compared to corporate-backed securities, there wasn’t a long record for the mortgage-backed version, which came into vogue relatively recently. This lack of historical context hid a lot of risk in the CDOs, and since these types of securities weren’t being priced on the open market, extra risk was already built in.

The way those mortgage-backed securities are valued may soon become everyone’s problem. As I write this, the Senate has passed the $700 billion economic bailout package and the House is getting ready to vote on the measure. If it becomes law — and this is by no means assured — the U.S. government will have to figure out how to value all these mortgage-based CDOs as well as other stressed assets like their corporate-backed counterparts.

Julius Finance, a firm that specializes in CDO valuation using HPC technology, has called for the use of standardized house price appreciation scenarios in the valuation of complex financial products. In a press release on Tuesday, Joseph Cotton, the company’s CEO, stated: “For years, banks have been able to tranche up CDOs and sell the slices for more than the cost of the pie — with inconsistent valuation and ratings models not exactly standing in the way. Now, there is the possibility of the entire financial community playing that game on a vast scale with the taxpayer on the other end of the deal.”

I spoke with Cotton earlier in the week and asked him how he thinks the government should proceed. According to him, there needs to be a standard set of assumptions and scenarios used to value homes. This, he says, is one of the greatest sources of uncertainty in these products for investors, which allows sellers to game the system. “What you don’t want to see is a number of independent valuations of these products being done by different parties with very different assumptions,” says Cotton.

At this point no plan has been put forth by either the Treasury of the Fed to bring any rigorous technology to bear on the problem. According to Cotton, if the government is not careful, taxpayers will end up paying very high prices for these securities relative to what any other investor would be prepared to spend. But, he says, even though the financial instruments have become exceedingly complicated, these can be priced today with existing technology. Although some experts claim these products are impossible to value because of their complexity and lack of liquidity, Cotton believes that’s a fallacy.

He says all you really need is a significant sized cluster (1,000 nodes should be plenty), the loan database corresponding to the assets in question, and the software model that incorporates all the load attributes plus the structure of the deals. The model has to take into account home price appreciation/depreciation, prepayments, defaults, interest rates, and all cash flows as they get fed back into the various structured finance products associated with the mortgages. Software such as this exists today — it’s just not being applied at this scale. According to Cotton, the entire project could probably be accomplished for a few tens of millions of dollars — a small fraction of the $700 billion bailout.

Whether the Feds follow through with the rescue plan or not, it seems almost certain that the government is going to crack down on the rating services, either through regulation or by incorporating much of their function into the government itself. From my perspective, the latter path actually seems like the better way to go. Having the financial sector in charge of the asset ratings would be like analogous to the oil and gas industry controlling the global warming models. As one blog commentator put it: “The housing bubble was never about financing assets — it was all about financing financing.”

Subscribe to HPCwire's Weekly Update!

Be the most informed person in the room! Stay ahead of the tech trends with industy updates delivered to you every week!

Mira Supercomputer Enables Cancer Research Breakthrough

November 11, 2019

Dynamic partial-wave spectroscopic (PWS) microscopy allows researchers to observe intracellular structures as small as 20 nanometers – smaller than those visible by optical microscopes – in three dimensions at a mill Read more…

By Staff report

IBM Adds Support for Ion Trap Quantum Technology to Qiskit

November 11, 2019

After years of percolating in the shadow of quantum computing research based on superconducting semiconductors – think IBM, Rigetti, Google, and D-Wave (quantum annealing) – ion trap technology is edging into the QC Read more…

By John Russell

Tackling HPC’s Memory and I/O Bottlenecks with On-Node, Non-Volatile RAM

November 8, 2019

On-node, non-volatile memory (NVRAM) is a game-changing technology that can remove many I/O and memory bottlenecks and provide a key enabler for exascale. That’s the conclusion drawn by the scientists and researcher Read more…

By Jan Rowell

What’s New in HPC Research: Cosmic Magnetism, Cryptanalysis, Car Navigation & More

November 8, 2019

In this bimonthly feature, HPCwire highlights newly published research in the high-performance computing community and related domains. From parallel programming to exascale to quantum computing, the details are here. Read more…

By Oliver Peckham

Machine Learning Fuels a Booming HPC Market

November 7, 2019

Enterprise infrastructure investments for training machine learning models have grown more than 50 percent annually over the past two years, and are expected to shortly surpass $10 billion, according to a new market fore Read more…

By George Leopold

AWS Solution Channel

Making High Performance Computing Affordable and Accessible for Small and Medium Businesses with HPC on AWS

High performance computing (HPC) brings a powerful set of tools to a broad range of industries, helping to drive innovation and boost revenue in finance, genomics, oil and gas extraction, and other fields. Read more…

IBM Accelerated Insights

Atom by Atom, Supercomputers Shed Light on Alloys

November 7, 2019

Alloys are at the heart of human civilization, but developing alloys in the Information Age is much different than it was in the Bronze Age. Trial-by-error smelting has given way to the use of high-performance computing Read more…

By Oliver Peckham

IBM Adds Support for Ion Trap Quantum Technology to Qiskit

November 11, 2019

After years of percolating in the shadow of quantum computing research based on superconducting semiconductors – think IBM, Rigetti, Google, and D-Wave (quant Read more…

By John Russell

Tackling HPC’s Memory and I/O Bottlenecks with On-Node, Non-Volatile RAM

November 8, 2019

On-node, non-volatile memory (NVRAM) is a game-changing technology that can remove many I/O and memory bottlenecks and provide a key enabler for exascale. Th Read more…

By Jan Rowell

MLPerf Releases First Inference Benchmark Results; Nvidia Touts its Showing

November 6, 2019

MLPerf.org, the young AI-benchmarking consortium, today issued the first round of results for its inference test suite. Among organizations with submissions wer Read more…

By John Russell

Azure Cloud First with AMD Epyc Rome Processors

November 6, 2019

At Ignite 2019 this week, Microsoft's Azure cloud team and AMD announced an expansion of their partnership that began in 2017 when Azure debuted Epyc-backed ins Read more…

By Tiffany Trader

Nvidia Launches Credit Card-Sized 21 TOPS Jetson System for Edge Devices

November 6, 2019

Nvidia has launched a new addition to its Jetson product line: a credit card-sized (70x45mm) form factor delivering up to 21 trillion operations/second (TOPS) o Read more…

By Doug Black

In Memoriam: Steve Tuecke, Globus Co-founder

November 4, 2019

HPCwire is deeply saddened to report that Steve Tuecke, longtime scientist at Argonne National Lab and University of Chicago, has passed away at age 52. Tuecke Read more…

By Tiffany Trader

Spending Spree: Hyperscalers Bought $57B of IT in 2018, $10B+ by Google – But Is Cloud on Horizon?

October 31, 2019

Hyperscalers are the masters of the IT universe, gravitational centers of increasing pull in the emerging age of data-driven compute and AI.  In the high-stake Read more…

By Doug Black

Cray Debuts ClusterStor E1000 Finishing Remake of Portfolio for ‘Exascale Era’

October 30, 2019

Cray, now owned by HPE, today introduced the ClusterStor E1000 storage platform, which leverages Cray software and mixes hard disk drives (HDD) and flash memory Read more…

By John Russell

Supercomputer-Powered AI Tackles a Key Fusion Energy Challenge

August 7, 2019

Fusion energy is the Holy Grail of the energy world: low-radioactivity, low-waste, zero-carbon, high-output nuclear power that can run on hydrogen or lithium. T Read more…

By Oliver Peckham

Using AI to Solve One of the Most Prevailing Problems in CFD

October 17, 2019

How can artificial intelligence (AI) and high-performance computing (HPC) solve mesh generation, one of the most commonly referenced problems in computational engineering? A new study has set out to answer this question and create an industry-first AI-mesh application... Read more…

By James Sharpe

Cray Wins NNSA-Livermore ‘El Capitan’ Exascale Contract

August 13, 2019

Cray has won the bid to build the first exascale supercomputer for the National Nuclear Security Administration (NNSA) and Lawrence Livermore National Laborator Read more…

By Tiffany Trader

DARPA Looks to Propel Parallelism

September 4, 2019

As Moore’s law runs out of steam, new programming approaches are being pursued with the goal of greater hardware performance with less coding. The Defense Advanced Projects Research Agency is launching a new programming effort aimed at leveraging the benefits of massive distributed parallelism with less sweat. Read more…

By George Leopold

AMD Launches Epyc Rome, First 7nm CPU

August 8, 2019

From a gala event at the Palace of Fine Arts in San Francisco yesterday (Aug. 7), AMD launched its second-generation Epyc Rome x86 chips, based on its 7nm proce Read more…

By Tiffany Trader

D-Wave’s Path to 5000 Qubits; Google’s Quantum Supremacy Claim

September 24, 2019

On the heels of IBM’s quantum news last week come two more quantum items. D-Wave Systems today announced the name of its forthcoming 5000-qubit system, Advantage (yes the name choice isn’t serendipity), at its user conference being held this week in Newport, RI. Read more…

By John Russell

Ayar Labs to Demo Photonics Chiplet in FPGA Package at Hot Chips

August 19, 2019

Silicon startup Ayar Labs continues to gain momentum with its DARPA-backed optical chiplet technology that puts advanced electronics and optics on the same chip Read more…

By Tiffany Trader

Crystal Ball Gazing: IBM’s Vision for the Future of Computing

October 14, 2019

Dario Gil, IBM’s relatively new director of research, painted a intriguing portrait of the future of computing along with a rough idea of how IBM thinks we’ Read more…

By John Russell

Leading Solution Providers

ISC 2019 Virtual Booth Video Tour

CRAY
CRAY
DDN
DDN
DELL EMC
DELL EMC
GOOGLE
GOOGLE
ONE STOP SYSTEMS
ONE STOP SYSTEMS
PANASAS
PANASAS
VERNE GLOBAL
VERNE GLOBAL

Intel Confirms Retreat on Omni-Path

August 1, 2019

Intel Corp.’s plans to make a big splash in the network fabric market for linking HPC and other workloads has apparently belly-flopped. The chipmaker confirmed to us the outlines of an earlier report by the website CRN that it has jettisoned plans for a second-generation version of its Omni-Path interconnect... Read more…

By Staff report

Kubernetes, Containers and HPC

September 19, 2019

Software containers and Kubernetes are important tools for building, deploying, running and managing modern enterprise applications at scale and delivering enterprise software faster and more reliably to the end user — while using resources more efficiently and reducing costs. Read more…

By Daniel Gruber, Burak Yenier and Wolfgang Gentzsch, UberCloud

Dell Ramps Up HPC Testing of AMD Rome Processors

October 21, 2019

Dell Technologies is wading deeper into the AMD-based systems market with a growing evaluation program for the latest Epyc (Rome) microprocessors from AMD. In a Read more…

By John Russell

Intel Debuts Pohoiki Beach, Its 8M Neuron Neuromorphic Development System

July 17, 2019

Neuromorphic computing has received less fanfare of late than quantum computing whose mystery has captured public attention and which seems to have generated mo Read more…

By John Russell

Rise of NIH’s Biowulf Mirrors the Rise of Computational Biology

July 29, 2019

The story of NIH’s supercomputer Biowulf is fascinating, important, and in many ways representative of the transformation of life sciences and biomedical res Read more…

By John Russell

Xilinx vs. Intel: FPGA Market Leaders Launch Server Accelerator Cards

August 6, 2019

The two FPGA market leaders, Intel and Xilinx, both announced new accelerator cards this week designed to handle specialized, compute-intensive workloads and un Read more…

By Doug Black

With the Help of HPC, Astronomers Prepare to Deflect a Real Asteroid

September 26, 2019

For years, NASA has been running simulations of asteroid impacts to understand the risks (and likelihoods) of asteroids colliding with Earth. Now, NASA and the European Space Agency (ESA) are preparing for the next, crucial step in planetary defense against asteroid impacts: physically deflecting a real asteroid. Read more…

By Oliver Peckham

When Dense Matrix Representations Beat Sparse

September 9, 2019

In our world filled with unintended consequences, it turns out that saving memory space to help deal with GPU limitations, knowing it introduces performance pen Read more…

By James Reinders

  • arrow
  • Click Here for More Headlines
  • arrow
Do NOT follow this link or you will be banned from the site!
Share This