Hubris

One 'Quant' Sees Shakeout for the Ages - '10,000 Years' -- WSJ

This article might be free (it was when I generated the link), or it might be subscribers-only. But in any event, it's a pretty humorous piece about what happens when a bunch of 'the smartest guys in the room' get together to manage money. They put together a set of computer models based on an arbitrage model, scoop up a few million bucks of customer money, borrow a few billion more, sit back and make money.

Except, of course, since the models are based on history, they don't do a very good job of predicting the future, and suddenly your models start behaving like a 10,000 pound bomb headed for Saddam's bunker -- straight down and accelerating.

Now the funny part is what this particular "smartest guy in the room," Matthew Rothman, has to say:

On Thursday, Mr. Rothman published an industry note explaining the situation and pleading with quant investors to remain calm. "Self-fulfilling prophesies of losses can come true if investors stampede and head for the door in unison," he said in the note. "We certainly hope this situation does not materialize and stress the need for investor calm."

Thereby providing a real-world example of the prisoner's dilemma: If all of these quant-based hedge funds sit tight, they'll probably all survive, although they won't make much money. However, the first fund to bolt stands to get out with most of its money intact, although this will quickly lead all funds to head for the exits, causing the broader meltdown Mr. Rothman fears.