Wednesday, September 15, 2010

Some Numbers for Quants to Contemplate

Quants are those notorious number crunchers and equation designers who have failed to comprehend the basic lesson taught to us all by Friedrich Hayek in is book on methodology, The Counter-Revolution of Science.

In the book, Hayek argued that social scientists who used mathematical equations to mimic the physical sciences suffered from an inferiority complex. He argued that because the social sciences (This includes the stock market) dealt with human action, there were no constants such as exist in the physical sciences. There is no equivalent in the social sciences, according to Hayek, of say the physical fact that water freezes at 32 degrees.

Hayek argued that any one attempting to create such equations in the social sciences was creating a faulty equation.

Quants year after year, as almost a tribute to Hayek, continue to lose billions of dollars ignoring Hayek's warning and build econometric models that blow up in a fashion no less spectacular than a shooting star.

NYT writes:
They were revered as the brightest minds in finance, the “quants” who could outwit Wall Street with their Ph.D.’s and superfast computers.

But after blundering through the financial panic, losing big in 2008 and lagging badly in 2009, these so-called quantitative investment managers no longer look like geniuses, and some investors have fallen out of love with them.

The combined assets of quantitative funds specializing in United States stocks have plunged to $467 billion, from $1.2 trillion in 2007, a 61 percent decline, according to eVestment Alliance, a research firm. That drop reflects both bad investments and withdrawals by clients.

The assets of a broader universe of quant hedge funds have dwindled by about $50 billion. One in four quant hedge funds has closed since 2007, according to Lipper Tass.
A decline of 61% and a plunge of $467 billion aren't constants but you would think quants would contemplate these staggering numbers and possibly pick up the Hayek book to get a clue as to why they are so terribly wrong so often.

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