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What happened to the quants in August 2007? Evidence from factors and transactions data

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  • Khandani, Amir E.
  • Lo, Andrew W.

Abstract

Using the simulated returns of long/short equity portfolios based on five valuation factors, we find evidence that the "Quant Meltdown" of August 2007 began in July and continued until the end of 2007. We simulate a high-frequency marketmaking strategy, which exhibited significant losses during the week of August 6, 2007, but was profitable before and after, suggesting that the dislocation was due to market-wide deleveraging and a sudden withdrawal of marketmaking risk capital starting August 8. We identify two unwinds - one on August 1 starting at 10:45am and ending at 11:30am, and a second at the open on August 6, ending at 1:00pm - that began with stocks in the financial sector, long book-to-market, and short earnings momentum.

Suggested Citation

  • 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.
  • Handle: RePEc:eee:finmar:v:14:y:2011:i:1:p:1-46
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    More about this item

    Keywords

    Systemic risk August 2007 Hedge funds Market-making Flash crash;

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G2 - Financial Economics - - Financial Institutions and Services
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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