The quant quake was so scary Goldman's CFO started babbling stupid stuff. More after the jump.
From Institutional Investor:
Fund managers who survived the quant bloodbath of August 2007 say the strategy is safer ten years later. But with its popularity soaring to new heights, some wonder whether crowded trades — and rising leverage — will lead to another downfall.
Ten years ago, during the second week of a sultry New York
August, Michael Mendelson was getting a sandwich at the Subway
shop near the Greenwich, Connecticut, office of AQR Capital
Management when all hell broke loose. As Mendelson glanced at
his BlackBerry, out of nowhere, it seemed, AQR’s funds
were in the red.
Very quickly, losses started snowballing, with AQR’s
flagship fund down 13 percent during the first ten days of
August before recovering all of it by month’s end.
“You didn’t know how far it was going to go,”
recalls Mendelson, a principal at AQR.
AQR was not alone. Some of the biggest and smartest hedge
funds in the world suddenly tumbled in tandem, as their
algorithmic trading systems went haywire.
As the events unfolded, other hedge fund managers scurried
from their idyllic Hamptons retreats to contain the damage and
lashed out at the quants, who turned out to be massively
overleveraged and highly correlated — triggering an
unwinding that was a preview of a collapse that would befall
the financial world a year later. “‘These damn
quants. They couldn’t get a date in high school, and now
they f——ked my month,’” was the joke Peter
Muller, who was running a secretive internal quant fund at
Morgan Stanley at the time, liked to tell afterward,
paraphrasing the frustrated fundamental managers.
But to everyone making high-stakes computerized investment
bets, it wasn’t funny — it was shocking. “We had
never seen anything like this before. . . . We were trained in
statistics. For all intents and purposes this shouldn’t
have happened,” says a manager of a major quant hedge fund
who lived through the event, sleeping in his Wall Street office
to try to contain the damage.
After a four-day quant rout, the Dow fell almost 400 points,
then began to recover, with little overall effect on the
market. But several funds ultimately did not survive the chaos
that started that summer. Goldman Sachs Asset Management, which
in 2006 ran the largest hedge fund empire in the U.S.,
eventually ended up shuttering two of its most prestigious
funds, Global Alpha and Global Equity Opportunities, after
losing billions of dollars. Tykhe Capital, whose funds had lost
between 17 percent and 31 percent by August 9, also eventually
shut down....MORE
For more on the quantpocalypse here's MIT's uberquant Andrew Lo via the New York Fed:
"What happened to the quants in August 2007? Evidence from factors and transactions data∗"
(
77 page PDF)
From 2012's "
David Viniar retiring as Goldman CFO (GS)":
.....*In August 2007 the market and in particular the funds suffered what came to be called the "
Quant Quake".
As the
Financial Times reported on Aug. 13, Mr. Viniar said one of the dumbest things of his life:
“We were seeing things that were 25-standard deviation moves, several days in a row”
In March 2009 we posted "
David Viniar, CFO of Goldman Sachs Blows Smoke at Journalists on AIG" which had this bit regarding the 25 Sigma comment:
Several folks, when they finally quit laughing, pointed out how blatently Mr. V was spinning.
Most however underestimated how infrequent 25SD events are, the most common guess being once in 100,000 years. Tee hee.
In a snappy little eight page paper "How Unlucky is 25 Sigma" we see that at 7 Sigma the odds are:
...The reader will note that as k gets bigger the probabilities of a k-sigma event fall
extremely rapidly:
• a 3-sigma event is to be expected about every 741 days or about 1 trading day
in every three years;
• a 4-sigma event is to be expected about every 31,560 days or about 1 trading
day in 126 years (!);
• a 5-sigma event is to be expected every 3,483,046 days or about 1 day every
13,932 years(!!)
• a 6-sigma event is to be expected every 1,009,976,678 days or about 1 day
every 4,039,906 years;
• a 7-sigma event is to be expected every 7.76e+11 days – the number of zero
digits is so large that Excel now reports the number of days using scientific
notation, and this number is to be interpreted as 7.76 days with decimal point
pushed back 11 places. This frequency corresponds to 1 day in 3,105,395,365
years....
The
authors go on to describe the problems involved in computing numbers on
the cosmological scales required for 25 standard deviations. A good
read, both for the statistically challenged and for pros like Viniar, a
very highly paid PR guy, in addition to his CFO duties.
I was so tickled by that little paper that we posted on it a second time, the day MIT added it to their Physics arXive:
When Goldman Sachs was Really, Really Unlucky (GS)
And a third time in 2011:
"How Unlucky is 25-Sigma?" (and a huge apology) GS; C; BST; UBS; MER
We have more on Mr. V. but I'll always think of him as frozen in 2007.
