Friday, August 17, 2007

Quant Correlations

Sorry, but I found this one quite funny. Even though I was out of it last week, as I get caught up, this story stays on my mind.

So if all of these quant funds are sitting on proprietary models, where was the protection? Where were the hedges? How much leverage was/is in play? Liquidation obviously spread to other markets so that these funds could meet margin calls and generally de-leverage.

From my reading, the valuation factor was what kicked most of these in the ass. Stat arb plays got reversed, shorts had to be covered while longs got whacked. Beautiful! Now, I recall seeing an article that mentioned comments from someone at Goldman to the effect that they had too much weight on the valuation factor and not enough on their proprietary factors. So here's a stupid question - why? Aren't the proprietary factors what earn you your money? I mean, it doesn't take a genius to figure out that most of the quant funds were executing similar strategies and even similar models. How much originality can there really be? No idea is original, in my opinion. However, everyone can tweak their models in various ways, and that should be where the money is. So if Goldman had proprietary factors in their model(s) which were not being weighted as heavily as standard valuation models, you really have to wonder what you're paying for.

Don't get me wrong. This is not simply a Goldman issue. It looks like lots of quants got dinged on this one. Highbridge, AQR, Campbell & Company and Renaissance are just a few of the names I've seen reported. Clearly there were more, although some probably got out sooner, or have held on longer. (Even though I doubt that last one, because anyone who got whacked for a larger percentage than Goldman was going to be outed by an investor.)

Anyway, I have to admit that although I am taking a serious hit in my portfolio, I am enjoying watching this credit crunch and sell-off. Do I like losing money? Oh hell naw! However, the day of reckoning was long overdue. Thankfully I have some cash available to put to use. I've been waiting for this, particularly in the housing market, for years.

Until next time...

Update: I found one of the articles talking about these "crowded factors".

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