CAIA Level II: Advanced Core Topics in Alternative Investments, 2nd Edition

37.6 THE GREAT QUANT MELTDOWN OF AUGUST 2007

One of the most insightful summaries of the quant meltdown of August 2007 comes from a Columbia Business School case study by Ang (2008), which discusses the buildup and the eventual meltdown that occurred.

What happens when quant strategies get too crowded? And how much impact could a group of quants2 actually have on financial markets? Quants are likely to have lofty academic backgrounds—for example, PhDs in mathematics, statistics, physics, economics, or finance. Some quants are internationally renowned research scientists who later ventured into the financial markets. Arguably, the grandfather of all quants is Edward Thorp, who had a successful career playing blackjack prior to his success in hedge funds (Thorp 1962).

As discussed in previous sections, all quant strategies are not the same, differing in holding periods, alpha sources, markets traded, and so on. Quants are also a minority when compared to all the other types of hedge fund managers; such a relatively small group of players would seemingly have a rather limited impact on the financial markets. Interestingly enough, however, the crowded quant strategies caused much financial market turmoil, although it appears to have largely been limited to the destruction of other quant funds and not the overall market.

In 2004, approximately $10 billion was invested in quant funds (according to Hedge Fund Research, Inc.). By June 2007, that number had quadrupled to $40.7 billion. ...