"Crowded Spaces and Copycat Risk Management. More Evidence from the Crisis of Crowding"
After writing his provocative book, The Crisis of Crowding, Dr. Chincarini continues his research on crowding and finds that crowding may occur from a less than obvious source – risk management.
In recent years, a new form of risk has been recognized. This risk is the risk of crowded spaces. That is, how the saturation of a particular trading strategy can lead to a mis-measurement of the future expected returns and risks of the trading strategy. The primary focus of this risk has to do with copycat trading, whereby traders or investors engage in a similar trading strategy. As too many dollars chase the same strategy, the opportunity fades away but leaves the remaining traders at greater risk exposure. This paper focuses on an entirely neglected source of crowding. The crowding explicitly from the risk management process. In particular, this paper focuses on equity portfolio managers that use similar risk models and examines the extent to which these similar risk models can mis-measure risk and lead to crowding of the investment space, even when the investment models are completely unrelated to one another. Our empirical analysis with real-world professional portfolio management data finds that the risk modeling process leads to crowding and mis-measured risk. Interestingly, we find a rise in crowding due to portfolio construction immediately before the quant crisis of 2007. We also show how a simple method of altering the eigenvalue structure can reduce the average crowding from portfolio management by 20%, and in some cases as high as 61%. We also find that crowding in the financial system would be lower if the distribution of risk model usage amongst portfolio managers was more diversified.
Dr. Ludwig Chincarini is the author of one of the classic books in the field of portfolio management entitled Quantitative Equity Portfolio Management and he has just released a new book explaining the causes of the financial crisis entitled The Crisis of Crowding. He has published numerous articles in finance and economics.
Dr. Chincarini is currently an Associate Professor of Finance in the School of Management at the University of San Francisco with over fifteen years of experience in the financial industry specializing in portfolio management, quantitative equity management, and derivatives. Prior to that he was a member of the academic council of Index IQ, where he was instrumental in creating and developing some of the newest alternative ETFs, like QAI (the first hedge fund replicator), CPI (the first real return-inflation hedged vehicle), and MNA (the first risk-arbitrage ETF), as well as others.
He was Director of Research at Rydex Global Advisors (now Guggenheim), where he co-developed the S&P 500 equal-weight index, designed the successful ETF, RSP, and helped launch the Rydex ETF program.
He helped build an internet brokerage firm, FOLIOfn, designing its innovative basket trading and portfolio management platform. He also worked at the Bank for International Settlements (BIS) and Schroders.
He received a PhD from the Massachusetts Institute of Technology and a BA from the University of California at Berkeley.
FOR MORE INFO: www.ludwigbc.com
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12:00pm until 1:30pm
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SF CA 94104
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