Every new entity faces the task of explaining its purpose, its raison d’être. In this first blog post, I am going to do this for Next Quant by telling the reader a story about a historical figure, Thales of Miletus. Explaining Next Quant’s role is especially important, given the fact that the most people don’t really understand what “quants” do.
I believe that Thales of Miletus[1] can be regarded as the first quant. As described by Aristotle, 2,400 years ago, Thales was a poor, but erudite philosopher. He was an accomplished mathematician and astronomer, and the first person to use the scientific method. Thales was apparently challenged by the question “If you’re so smart, why ain’t you rich?”[2]
He set about answering this by forecasting the weather for the approaching olive harvest and realized that it was very likely to be a bumper crop. He paid the owners of the local olive presses a small deposit in exchange for the exclusive right to the use of presses at harvest time. His strategy paid off - he turned out to be correct and the demand for olive presses exploded. Now Thales could charge a much higher price and thus made his fortune on (what we would call today) his option on the olive presses.
The type of contract that Thales used is not different from modern derivatives. We do not know the details of his contract, but it is possible that his deposit gave him the right, but not the obligation to use the olive presses. At harvest time, if Thales decided to use them, he had to pay a rent price that had been fixed at the time of signing the contract. If he decided to pass on renting them, he would have had to lose his deposit. Or perhaps the agreement required Thales to rent the presses at harvest time at some negotiated price. In that case, this would have been a forward contract.
Thales applied the scientific method and his knowledge to a commercial problem: the future price to rent olive presses. Modern day quants would construct a model that describes the effect of weather on the size of the olive crop, and perhaps another one that relates the size of the crop and prices to rent olive presses. These two models, coupled with a weather forecast can help determine the range of future prices. In that sense, Thales of Miletus could be the first quant known to us.
There is an additional moral in this story for the owners of the olive presses. They were clearly behind the curve in charging what turned out to be a low price to rent their equipment. Had they consulted someone who used similar methods to Thales, they could have adjusted their price to their benefit.
These days it is increasingly common for asset owners and other participants in the energy and commodity markets to employ quants. The reason for this is that market winners are often determined by the quality of their quantitative analysis and the resulting models. So don’t be like the owners of the olive presses. Make sure that you employ sound quantitative analysis in your decision making process!