It's a bleak time for the financial markets. We've seen financial institutions fall and governments around the world struggling to stabilise the markets. But who is to blame? According to media reports there are two suspects in the dock: the "rocket scientists" (a.k.a. the financial mathematicians) who provided the information behind the market's decisions, or the greedy bankers who only thought about quick profits and their end-of-year bonuses.
But just what role does maths have in the financial market? Most of us will have come into direct contact with financial maths when applying for a loan from a high street bank. Rather than the bank manager relying on how well they know you personally, as might have happened in the past, now loan decisions are based on statistical models. But these robust mathematical models predicting whether or not someone will be able to repay their loan did not avert the subprime mortgages in the US , the first domino to fall in the current crisis. Loans were still given to people the models predicted would default on their payments.
The failure of these high-risk loans infected the whole financial markets thanks to the use of credit derivatives to share the credit risk around. These complex financial instruments were profitable in a booming market, but are now paralysing the financial system. Did the mathematicians involved in developing these products get their sums wrong?
On the other hand, if the real culprits are the bankers, then what lead them to make such bad decisions? Could it have been down to their biochemical make up, and would the problem be solved by more diversity on the trading floor?
Read more for answers to all these questions...
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