Quasirandom Ramblings

Brian Hayes in American Scientist:

In the early 1990s Spassimir Paskov, then a graduate student at Columbia University, began analyzing an exotic financial instrument called a collateralized mortgage obligation, or CMO, issued by the investment bank Goldman Sachs. The aim was to estimate the current value of the CMO, based on the potential future cash flow from thousands of 30-year mortgages. This task wasn’t just a matter of applying the standard formula for compound interest. Many home mortgages are paid off early when the home is sold or refinanced; some loans go into default; interest rates rise and fall. Thus the present value of a 30-year CMO depends on 360 uncertain and interdependent monthly cash flows. The task amounts to evaluating an integral in 360-dimensional space.

There was no hope of finding an exact solution. Paskov and his adviser, Joseph Traub, decided to try a somewhat obscure approximation technique called the quasi–Monte Carlo method. An ordinary Monte Carlo evaluation takes random samples from the set of all possible solutions. The quasi variant does a different kind of sampling—not quite random but not quite regular either. Paskov and Traub found that some of their quasi–Monte Carlo programs worked far better and faster than the traditional technique. Their discovery would allow a banker or investor to assess the value of a CMO with just a few minutes of computation, instead of several hours.

It would make a fine story if I could now report that the subsequent period of “irrational exuberance” in the financial markets—the frenzy of trading in complex derivatives, and the sad sequel of crisis, collapse, recession, unemployment—could all be traced back to a mathematical innovation in the evaluation of high-dimensional integrals. But it’s just not so; there were other causes of that folly.

On the other hand, the work of Paskov and Traub did have an effect: It brought a dramatic revival of interest in quasi–Monte Carlo.

More here.