The New Math: Quantitative hedge funds are pressing into new realms of science

Quote from ProfitTakgFool:

Hey MAESTRO, I wasn't trying to pee in your cup. Hope you didn't take it that way. I'm not ripping on Quants because I a fair amount of Quant work myself. I'm ripping on the folks who are criticizing those running through troubled times. Granted, these hedge funds should have had "what if" strategies but chances are many of them will be back. And of course, some will never return.
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No, not at all! I was just using your quote to illustrate my thoughts. I am simply ticked off by this "witch hunt" on Quants, that's all.
Good posts,
Cheers
 
Excellent!

Quote from nitro:

I agree with everything you say but one thing: these people are not stupid, and something as simple as variable x instead of variable y has been looked at. It is as if they were assuming the gravitational constant on the Earth, and all of a sudden g switches to the gravitation constant on the moon. Note the inputs are the same, but they assumed a constant, when in fact it may be variable. What is worse, there may be a lower bound as to what the value of g is to make the equations of motion work (tradeable). They continued to trade the strategy in a moon-gravity field, banging their heads against a wall. Perhaps an even better example is Einstein's Cosmological constant in his field equations, where the action changes based on it's value!

No, I say something at the core of markets that has drastic consequences has changed certain edge of quantitative strategies to negative. I have my own theories as to what it(they) is/are...

nitro
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Quote from makloda:

Yes, one leveraged relative value guy blows up so all hedge funds are bound by the same fate. Remember Jeffrey Skilling at Enron? They blew up so according to your logic each and every public company on earth must also blow up.
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No,according to my logic,talk is cheap.

And my point was that Meriwether's 'comeback' fund is now in trouble too.
 
I think that one of the things that might be underlying the fundamental changes in the markets this past year is the quants themselves. The popular press likes to talk about all of the "volatility caused by hedgefunds", but most of the quant-based hedge funds are probably running mean-reversion types of strategies, so under normal circumstances they will tend to reduce volatility. Furthermore, the mean-reversion trading strategies will tend to drive markets towards more mean-reversion.

So we had several years of unusually low volatility as more and more quant funds came into the market trading mean-reversion strategies. Then last year when the credit crisis spilled over into the equity markets, quant funds went out of business and/or scaled back the amount of capital they could deploy. Less capital in mean reversion strategies causes the markets to mean-revert less, which makes it harder for the remaining quant funds that are still trading the same strategies the same way.

With less capital in the mean-reversion trade providing liquidity, we get this type of market we have now with the wide ranges, lots of trend days, etc...

So I guess what I'm saying is that the quant funds going out of business might be at the heart of what has changed in the market, and that change is what is making it difficult for those quant funds that haven't adjusted to the new regime yet.

Anyone else have thoughts on this that they would like to share? Am I way off here?
 
Quote from GTG:

I think that one of the things that might be underlying the fundamental changes in the markets this past year is the quants themselves. The popular press likes to talk about all of the "volatility caused by hedgefunds", but most of the quant-based hedge funds are probably running mean-reversion types of strategies, so under normal circumstances they will tend to reduce volatility. Furthermore, the mean-reversion trading strategies will tend to drive markets towards more mean-reversion.

So we had several years of unusually low volatility as more and more quant funds came into the market trading mean-reversion strategies. Then last year when the credit crisis spilled over into the equity markets, quant funds went out of business and/or scaled back the amount of capital they could deploy. Less capital in mean reversion strategies causes the markets to mean-revert less, which makes it harder for the remaining quant funds that are still trading the same strategies the same way.

With less capital in the mean-reversion trade providing liquidity, we get this type of market we have now with the wide ranges, lots of trend days, etc...

So I guess what I'm saying is that the quant funds going out of business might be at the heart of what has changed in the market, and that change is what is making it difficult for those quant funds that haven't adjusted to the new regime yet.

Anyone else have thoughts on this that they would like to share? Am I way off here?
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I don't know. The assumption that all the hedge funds run mean reversion strategies is questionable. We, for example, do not run those. There are other types of statistical arbitrage that are still popular in Quant Funds. We have never changed our strategy since 2000 and we have survived Low and High volatility times. We are up nicely (21%) in 2008. However, we did have a small "dip" in January, but nothing big (around 5% or so).
 
Quote from GTG:

I think that one of the things that might be underlying the fundamental changes in the markets this past year is the quants themselves. The popular press likes to talk about all of the "volatility caused by hedgefunds", but most of the quant-based hedge funds are probably running mean-reversion types of strategies, so under normal circumstances they will tend to reduce volatility. Furthermore, the mean-reversion trading strategies will tend to drive markets towards more mean-reversion.

So we had several years of unusually low volatility as more and more quant funds came into the market trading mean-reversion strategies. Then last year when the credit crisis spilled over into the equity markets, quant funds went out of business and/or scaled back the amount of capital they could deploy. Less capital in mean reversion strategies causes the markets to mean-revert less, which makes it harder for the remaining quant funds that are still trading the same strategies the same way.

With less capital in the mean-reversion trade providing liquidity, we get this type of market we have now with the wide ranges, lots of trend days, etc...

So I guess what I'm saying is that the quant funds going out of business might be at the heart of what has changed in the market, and that change is what is making it difficult for those quant funds that haven't adjusted to the new regime yet.

Anyone else have thoughts on this that they would like to share? Am I way off here?
More...

There was an interesting paper I read on this recently. One thing is for certain, as more and more quant funds have jumped onto long/short mean reversion type strategies over the years, the expected daily returns have been diminishing in proportion. Meaning 1)markets are becoming more efficient against those types of strategies 2)quant funds need to take on more leverage to maintain the same level of returns, implying more likelyhood of systematic blowup over unexpected fat tails.

What was most interesting IMO, was that during august 7-9 last year, even though you don't see much variation on the major indices, there was a major blowup/fat tail between short/long funds in that period. Many couldn't handle the event as they received margin calls and forced liquidation. I have no doubt similar events have been occurring recently over the credit crunch/subprime debacle.

One conclusion the author drew, similar to yours, is that as less funds stay alive, the reduction in liquidity, causes more volatility in markets.
 
Quote from dtrader98:

There was an interesting paper I read on this recently. One thing is for certain, as more and more quant funds have jumped onto long/short mean reversion type strategies over the years, the expected daily returns have been diminishing in proportion. Meaning 1)markets are becoming more efficient against those types of strategies 2)quant funds need to take on more leverage to maintain the same level of returns, implying more likelyhood of systematic blowup over unexpected fat tails.

What was most interesting IMO, was that during august 7-9 last year, even though you don't see much variation on the major indices, there was a major blowup/fat tail between short/long funds in that period. Many couldn't handle the event as they received margin calls and forced liquidation. I have no doubt similar events have been occurring recently over the credit crunch/subprime debacle.

One conclusion the author drew, similar to yours, is that as less funds stay alive, the reduction in liquidity, causes more volatility in markets.
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Could you please post the link to this paper?
 
Quote from MAESTRO:

I don't know. The assumption that all the hedge funds run mean reversion strategies is questionable. We, for example, do not run those. There are other types of statistical arbitrage that are still popular in Quant Funds. We have never changed our strategy since 2000 and we have survived Low and High volatility times. We are up nicely (21%) in 2008. However, we did have a small "dip" in January, but nothing big (around 5% or so).
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Nice work MAESTRO!
 
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