What Happened to the Quants in August 2007?

Journal of Investment Management, Vol. 5, No. 4, Fourth Quarter 2007

Posted: 17 Jan 2008

See all articles by Amir Khandani

Amir Khandani

Massachusetts Institute of Technology (MIT)

Andrew W. Lo

Massachusetts Institute of Technology (MIT) - Laboratory for Financial Engineering

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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, quantitative market-neutral, long/short equities, August 2007

JEL Classification: G00

Suggested Citation

Khandani, Amir E. and Lo, Andrew W., What Happened to the Quants in August 2007?. Journal of Investment Management, Vol. 5, No. 4, Fourth Quarter 2007, Available at SSRN: https://ssrn.com/abstract=1084685

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