What Happened to the Quants in August 2007?: Evidence from Factors and Transactions Data

60 Pages Posted: 25 Oct 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)

Multiple version iconThere are 2 versions of this paper

Date Written: October 24, 2008

Abstract

During the week of August 6, 2007, a number of quantitative long/short equity hedge funds experienced unprecedented losses. It has been hypothesized that a coordinated deleveraging of similarly constructed portfolios caused this temporary dislocation in the market. Using the simulated returns of long/short equity portfolios based on five specific valuation factors, we find evidence that the unwinding of these portfolios began in July 2007 and continued until the end of 2007. Using transactions data, we find that the simulated returns of a simple marketmaking strategy were significantly negative during the week of August 6, 2007, but positive before and after, suggesting that the Quant Meltdown of August 2007 was the combined effects of portfolio deleveraging throughout July and the first week of August, and a temporary withdrawal of marketmaking risk capital starting August 8th. Our simulations point to two unwinds - a mini-unwind on August 1st starting at 10:45am and ending at 11:30am, and a more sustained unwind starting at the open on August 6th and ending at 1:00pm - that began with stocks in the financial sector and long Book-to-Market and short Earnings Momentum. These conjectures have significant implications for the systemic risks posed by the hedge-fund industry.

Keywords: hedge funds, systemic risk, market efficiency, statistical arbitrage, long/short equity

JEL Classification: G10, G12, G24

Suggested Citation

Khandani, Amir E. and Lo, Andrew W., What Happened to the Quants in August 2007?: Evidence from Factors and Transactions Data (October 24, 2008). Available at SSRN: https://ssrn.com/abstract=1288988 or http://dx.doi.org/10.2139/ssrn.1288988

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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Cambridge, MA 02142
United States

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