Tuesday, May 13, 2008

We Know What the Quants Did Last Summer

The FT’s “The Short View” columnist John Authers is blogging for FT Alphaville from Vancouver at the annual gathering of the CFA Institute
From FT Alphaville:

What will the quants do next? Judging by presentations in Vancouver, many think they have worked out what happened to them last August, and believe they have learned the lesson.

The main problems - known well enough by now - as presented by various quants here in Vancouver over the last two days seem to be as follows:

First, the quants had too much leverage (and available data could not tell them that this was going on).

Second, they crowded into trades, although this worked differently from the normal perception. The overlap in their holdings of stocks, which would have shown up in quite a lot of publicly available data, was not that great. Rather, they were crowded into particular “factors” - such as staying long in stocks with a low price-to-book ratio. This created the downdraft for them when the market turned in early August.

Third, they overconfident and continued to bet that relatively cheap stocks would beat relatively expensive stocks, even though by 2004 the spread between the two, after half a decade of outperformance by value strategies, was historically low. As Vadim Zlotnikov of Alliance Bernstein put it: “Value spreads were very low but they continued to pile into value arbitrage trades. They were betting that LBOS that had never previously made sense would continue.”>>>MORE

Two other posts in the series that I read:

  1. Seeing the Black Swans coming
  2. So if Taleb is so clever....