Quants, Strategic Speculation, and Financial Market Quality

Abstract

We study the effects of quantitative investing, an increasingly popular investment style, on financial market quality. Within a noisy REE model of strategic speculation with two informed traders, we define discretionary investing as fully strategic and quantitative investing as partially or fully myopic via its reliance on a backtested trading strategy. Growth in quantitative investing is modeled as the introduction of and greater backtest adherence by a quantitative investor. The former generally benefits financial market quality, while the latter worsens (improves) it when leading to less (more) aggressive trading than discretion — especially when endowed with less (more) precise information.

Keywords: investment management, quantitative funds, mutual funds, quants, liquidity, market quality

JEL Classification: G11, G12, G14, G23