Quantitative Investing and Market Instability

Abstract

The May 2010 Flash Crash and August 2007 Quant Meltdown raised concerns about the impact of quantitative investment strategies on market stability. Theory is split on whether quantitative investing dampens or exacerbates market instability. To test the theory we focus on mutual fund fire sales. We find that quantitative fund fire sales have a much larger impact on market instability than fire sales by traditional mutual funds. For the same magnitude fire sale, quantitative funds’ impact is over five times as large. The evidence suggests this is due to quantitative funds’ reliance on similar trading signals and sensitivity to the time-series of returns.

Keywords: Investment management, security selection, quantitative funds, mutual funds, fire sales, herding, market stability

JEL Classification: G11, G23, G40