How mathematician Ed Thorp uncovered a financial mystery 2 decades before the public found out. #spoiler In 1991, the consulting firm McKinsey was reviewing how its pension fund portfolio was doing when they found one with a returns graph that looked like this: The analysts at McKinsey were quite stumped, and they brought in a consultant of their own: Ed Thorp. You see, Ed Thorp is known as the “father of the quants”: he’s a renowned mathematician best known for his contributions to option pricing theory and role in developing quantitative trading strategies. This seemed a little suspicious to Thorp. It wasn't that the investment was growing way too quickly—it made around 1-3% per month—but that volatility was way too low for an equity fund. Ed Thorp found out that the strategy employed by the Fairfield Sentry fund was a collar strategy: within a portfolio of stocks, buy put options slightly below the stock price and sell calls slightly above the stock price. A collar strategy reduces downside risk at the expense of additional upside, so it would indeed limit the overall volatility. But Thorp knew that the fund should still lose money sometimes. The chances of never losing anything were extremely low. Thorp also found out that the fund's trade reports didn't match up with the volume data he got from the exchanges. He even went to Bear Stearns, and they couldn't account for how these trades were being executed. Something didn't add up. It was too good to be true, and it didn't seem like the trades were actually happening. That's when Thorp believed it was a fraud. So he told McKinsey's pension fund manager to pull out of its investment in that fund. The pension fund refused to do so, since the investment had been performing so well. It turns out the that fund was actually managed by Bernie Madoff, and Thorp had identified the Madoff's scheme back in 1991. By 2008, it was uncovered by Harry Markopolos that the returns posted by Bernie Madoff's ponzi scheme were indeed too good to be true. Consistent, steady, up and to the right returns of 1-2% per month. Ed Thorp found out that the strategy employed by the Fairfield Sentry fund was supposedly that within a portfolio of stocks, buy put option slightly below the stock price and sell calls slightly above the stock price. But Ed Thorp called bluff. You see, Ed Thorp is known as the “father of the quants”: he’s a renowned mathematician best known for his contributions to option pricing theory and role in developing quantitative trading strategies. Thorp could see that selling the options strategy supposedly employed in this portfolio just didn’t add up. Thorp was spot on. By 2008, it was uncovered by Harry Markopolos that the returns posted by Bernie Madoff's ponzi scheme were indeed too good to be true. #McKinsey #EdThorp #BernieMadoff #PonziScheme #investmentstrategy #financialfraud #quantitativetrading #collarstrategy #optionpricing #investing #finance #trivia #financetrivia #fraudprevention #financialhistory $BSC #BearSterns - @financefunfacts