Trader Talk

Market Drops: One Analyst's Opinion On What Happened

What caused the big market drops that began in August of last year? There’s a fascinating interview with Andrew Lo, director of MIT's Laboratory for Financial Engineering, in the new issue of Technology Review.

He says that the growing complexity of world markets makes "aberrations" like SocGen more likely to rock markets, but he makes a very interesting point about the start of all this volatility, back in August.

Remember all the craziness that began last August 7th and continued for several days? Here's his take on what happened:

--A large number of quantitative equity hedge funds lost money on those dates simultaneously, but no obvious market event occurred;

--It's likely that one large quantitative equity fund decided to unwind its portfolio, probably related to credit problems from the subprime mortgage market;

--The liquidation had a negative impact on other similarly positioned quantitative funds;

--A snowball effect ensued, with quant funds exiting at the same time.

Thus, there was no market "crash," just quant funds that were too similarly positioned.

Questions?  Comments?