For Wall Street’s Math Brains, Miscalculations
Complex Formulas Used by ‘Quant’ Funds Didn’t Add Up in Market Downturn
By Frank Ahrens
Washington Post Staff Writer
Tuesday, August 21, 2007; A01
They are the powerful, cerebral and offstage actors of Wall Street, but the recent turmoil in the financial markets has yanked them into the light.
They are the math geniuses of the quant funds.
Short for “quantitative equity,” a quant fund is a hedge fund that relies on complex and sophisticated mathematical algorithms to search for anomalies and non-obvious patterns in the markets. These glitches, often too small for the human eye, can present opportunities for short- and long-term trades that yield high-profit returns.
The models replace instinct. They try to turn historical trends into predictive science, using elegant mathematics seemingly above the comprehension of your average 401(k) participant or Wall Street fund manager.
Instead of veteran, market-savvy traders waving fistfuls of sell slips, the elite quant funds employ Nobel nerds with math PhDs, often divorced from the real world. It’s not for nothing that they are called “black-box” funds — opaque to outsiders, the boxes contain investment magic understood by only the wizards who conjured it up.
An extension of going to Vegas with a ‘sure-fire system,’ everyone thinks up ways to do the analysis by computer and get away for the weekend. Amazingly, the evidence was there for months and years that the housing bubble was headed for a wall. Evidence ignored by computer programs to sophisticated to see big pictures, tuned to profit from small anomalies.
Warren Buffett lost not a nickel, but then Warren didn’t lose his good judgment either.