When can it be dangerous to rely on a bloodless computer to make decisions? For foggy landings of a jet airplane, rule-based computers linked to radar and sensors can be great, but the pilots will always want the ability to override the computer. The recent mid-August meltdown of global credit, bond and stock markets has raised many questions about the use of computerized quantitative analysis. In an article in The New York Times,1 Clifford Asness, the co-founder of the money management firm AQR Capital Management, said, "'When we make a boatload of money, we get imitators, and our risks increase. That's how capitalism works.'" Do all computer-based decisions have an Achilles' heel making them vulnerable to making huge decision errors?
Asness was describing his firm's sophisticated "market neutral" computer models. The models simultaneously buy long and sell short positions in thousands of financial instruments in equal amounts. They do this by the minute to detect almost imperceptible undervalued instruments that have a rule-based measure of sales momentum while the total investment portfolio remains constant after pocketing the siphoned gains. The winning trades beat the averages. Asness' comment about imitators is as more of them trade, they materially affect market values and can cause "herd behavior."
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