Monday, June 2, 2008

Is Quantitative Trading alive or dead?

Scores of quantitative hedge funds have taken hits over past year that make NFL hits in Sunday football games appear to be minor league. Many have questioned if there is a future to the quantitative approach to trading the market, all the current models appear to be completely discredited. Yet to entire industry continues to drive forward, new algorithms are being created, however most are still focused on wringing raw profit out of the market based on differences in data input.

Similar to the movie Groundhog Day, repeating the same mistakes will only lead to a cycle of the same results. The continuing flawed premise is the over-optimization of models to focus on profit while ignoring risk.

A recent study by the CFA Institute outlines many of the issues with quantitative models used by Hedge Funds. Many factors have led to a complete decay in performance, leaving funds scrambling to unwind exposed positions. The information reveals that profits opportunities for quants are harder to find and exploit, while the updated strategies expose firms to increasing risk. The concept that firms will trade strategies that increase risk while possible gains are minimized bodes poorly for the industry.

A couple of HingeFire briefs have touched on this subject in the past (see Is there a future for Quant Funds and Quants search for new math). The complete 100+ page study from the CFA Institute is available for free in PDF format and is very educational. It can be downloaded here -