NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

What Happened To The Quants In August 2007?: Evidence from Factors and Transactions Data

Amir E. Khandani, Andrew W. Lo

NBER Working Paper No. 14465
Issued in November 2008
NBER Program(s):   AP

During the week of August 6, 2007, a number of quantitative long/short equity hedge funds experienced unprecedented losses. It has been hypothesized that a coordinated deleveraging of similarly constructed portfolios caused this temporary dislocation in the market. Using the simulated returns of long/short equity portfolios based on five specific valuation factors, we find evidence that the unwinding of these portfolios began in July 2007 and continued until the end of 2007. Using transactions data, we find that the simulated returns of a simple marketmaking strategy were significantly negative during the week of August 6, 2007, but positive before and after, suggesting that the Quant Meltdown of August 2007 was the combined effects of portfolio deleveraging throughout July and the first week of August, and a temporary withdrawal of marketmaking risk capital starting August 8th. Our simulations point to two unwinds---a mini-unwind on August 1st starting at 10:45am and ending at 11:30am, and a more sustained unwind starting at the open on August 6th and ending at 1:00pm---that began with stocks in the financial sector and long Book-to-Market and short Earnings Momentum. These conjectures have significant implications for the systemic risks posed by the hedge-fund industry.

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Published: Khandani, Amir E. & Lo, Andrew W., 2011. "What happened to the quants in August 2007? Evidence from factors and transactions data," Journal of Financial Markets, Elsevier, vol. 14(1), pages 1-46, February.

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