What Happened to the Quants in August 2007?

67 Pages Posted: 21 Sep 2007 Last revised: 17 Jan 2008

Amir Khandani

Massachusetts Institute of Technology (MIT)

Andrew W. Lo

Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER); Massachusetts Institute of Technology (MIT) - Computer Science and Artificial Intelligence Laboratory (CSAIL)

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Date Written: November 4, 2007

Abstract

During the week of August 6, 2007, a number of quantitative long/short equity hedge funds experienced unprecedented losses. Based on TASS hedge-fund data and simulations of a specific long/short equity strategy, we hypothesize that the losses were initiated by the rapid unwind of one or more sizable quantitative equity market-neutral portfolios. Given the speed and price impact with which this occurred, it was likely the result of a forced liquidation by a multi-strategy fund or proprietary-trading desk, possibly due to a margin call or a risk reduction. These initial losses then put pressure on a broader set of long/short and long-only equity portfolios, causing further losses by triggering stop/loss and de-leveraging policies. A significant rebound of these strategies occurred on August 10th, which is also consistent with the unwind hypothesis. This dislocation was apparently caused by forces outside the long/short equity sector - in a completely unrelated set of markets and instruments - suggesting that systemic risk in the hedge-fund industry may have increased in recent years.

Keywords: Hedge Funds, Long/Short Equity, Liquidity, Statistical Arbitrage, August 2007

JEL Classification: G10, G12, G20, E44

Suggested Citation

Khandani, Amir and Lo, Andrew W., What Happened to the Quants in August 2007? (November 4, 2007). Available at SSRN: https://ssrn.com/abstract=1015987 or http://dx.doi.org/10.2139/ssrn.1015987

Amir E. Khandani

Massachusetts Institute of Technology (MIT) ( email )

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Andrew W. Lo (Contact Author)

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

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National Bureau of Economic Research (NBER) ( email )

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Massachusetts Institute of Technology (MIT) - Computer Science and Artificial Intelligence Laboratory (CSAIL)

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