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

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. (C) 2010 Elsevier B.V. All rights reserved.