By DENNIS OVERBYE


Emanuel Derman expected to feel a letdown when he left particle physics for a job on Wall Street in 1985.

After all, for almost 20 years, as a graduate student at Columbia University in New York and a postdoctoral fellow at institutions like Oxford and the University of Colorado, he had mingled with Nobel laureates. How could managing money compare?

But the letdown never happened. Instead he fell in love with a corner of finance that dealt with stock options.

“Options theory is kind of deep in some way. It was very elegant; it had the quality of physics,”Dr.Derman explained recently with a bit of wistfulness, sitting in his office at Columbia, where he is now a professor of finance and a risk management consultant with Prisma Capital Partners.

Dr.Derman, who spent 17 years at Goldman Sachs and became managing director, was a forerunner of the many physicists and other scientists who have flooded Wall Street.

They are known as“quants”because they do quantitative finance. They apply skills they once hoped to use to solve the mysteries of the physical universe to making money.

This flood seems to be continuing, unabated by the worldwide economic collapse. Some quants analyze the stock market. Others churn out the computer models that analyze otherwise unmeasurable risks and profits of arcane deals, or run their own hedge funds and sift through vast universes of data for the slight disparities that can give them an edge.

But even the quants tend to agree that what they do is not quite science.

As Dr.Derman put it in his book“My Life as a Quant: Reflections on Physics and Finance,”“In physics there may one day be a Theory of Everything; in finance and the social sciences, you’re lucky if there is a useable theory of anything.”

Physicists began to follow the jobs from academia to Wall Street in the late 1970s. They arrived on Wall Street in the midst of a financial revolution. Among other things, rising inflation had made finances more complicated and risky, and it required increasingly sophisticated mathematical expertise to parse even simple investments like bonds. Enter the quant.

Stock options, however, were where this revolution was to have its greatest, and most famous, success. In the 1970s the late Fischer Black of Goldman Sachs, Myron S.Scholes of Stanford University and Robert C.Merton of Harvard had figured out how to price and hedge these options in a way that seemed to guarantee profits. The so-called Black- Scholes model has been the quants’gold standard ever since.

Dr.Merton and Dr.Scholes won the Nobel in economic science in 1997 for the stock options model. Only a year later Long Term Capital Management, a highly leveraged hedge fund whose directors included the two Nobelists, collapsed and had to be bailed out to the tune of $3.65 billion by a group of banks.

Afterward, a Merrill Lynch memorandum noted that the financial models“may provide a greater sense of security than warranted; therefore reliance on these models should be limited.”

That was a lesson apparently not learned.

Given the state of the world, it is fair to ask whether quants have any idea at all what they are doing.

Lee Smolin, a physicist at the Perimeter Institute for Theoretical Physics in Waterloo, Ontario, said,“What is amazing to me as I learn about this is how flimsy was the theoretical basis of the claims that derivatives and other complex financial instruments reduced risk, when their use in fact brought on instabilities.”

One of the most outspoken critics is Nassim Nicholas Taleb, a former trader and now a professor at New York University. He got an adulatory reception at the World Economic Forum in Davos this winter. In his best-selling book“The Black Swan,”Dr.Taleb argues that finance and history are dominated by rare and unpredictable events.

“Every trader will tell you that every risk manager is a fraud,”he said, and options traders used to get along fine before Black-Scholes.

“I think physicists should go back to the physics department and leave Wall Street alone,”he said.

Dr.Derman says models can be a useful guide as long as you do not confuse them with real science.

But do some people take the models too seriously-“Not the smart people,”Dr.Derman said.