Monday, August 13, 2007
The New York Times today has an article about several well-known quantitative hedge funds incurring significant losses in recent months. I was quoted in saying that traders running similar quantitative models could contribute to market volatility. This is certainly true if the strategies are trend-following. What puzzles me, however, is that most statistical arbitrage strategies are mean-reverting: they buy during investors' panic, and sell during investors' euphoria, and should be richly rewarded in this volatile market by providing sorely needed liquidity. And indeed, from my own experience as well as hearing from other traders, mean-reverting strategies are performing very well recently. So where did those losses come from? My guess is that, as I have observed before, many traditional stat arb strategies are getting boring and generating diminishing returns, and therefore many of the quantitative researchers are driven (by their own professional pride or their bosses) to come up with more exotic and higher-return strategies that ultimately may not stand the test of time. For us quants, remembering Occam's razor and that our job is to generate returns as opposed to producing brilliant mathematical models is often a hard lesson to learn.
Posted by Ernie Chan at 10:33 AM