Inside the Black Box

Preface to the Second Edition xiii Acknowledgments xvii Part ONE The Quant Universe Chapter 1 Why Does Quant Trading Matter? 3 The Benefit of Deep Thought 8 The Measurement and Mismeasurement of Risk 9 Disciplined Implementation 10 Summary 11 Notes 11 Chapter 2 An Introduction to Quantitative Trading 13 What Is a Quant? 14 What Is the Typical Structure of a Quantitative Trading System? 16 Summary 19 Notes 20 Part two Inside the Black Box Chapter 3 Alpha Models: How Quants Make Money 23 Types of Alpha Models: Theory-Driven and Data-Driven 24 Theory-Driven Alpha Models 26 Data-Driven Alpha Models 42 Implementing the Strategies 45 Blending Alpha Models 56 Summary 62 Notes 64 Chapter 4 Risk Models 67 Limiting the Amount of Risk 69 Limiting the Types of Risk 72 Summary 76 Notes 78 Chapter 5 Transaction Cost Models 79 Defining Transaction Costs 80 Types of Transaction Cost Models 85 Summary 90 Note 91 Chapter 6 Portfolio Construction Models 93 Rule-Based Portfolio Construction Models 94 Portfolio Optimizers 98 Output of Portfolio Construction Models 112 How Quants Choose a Portfolio Construction Model 113 Summary 113 Notes 115 Chapter 7 Execution 117 Order Execution Algorithms 119 Trading Infrastructure 128 Summary 130 Notes 131 Chapter 8 Data 133 The Importance of Data 133 Types of Data 135 Sources of Data 137 Cleaning Data 139 Storing Data 144 Summary 145 Notes 146 Chapter 9 Research 147 Blueprint for Research: The Scientific Method 147 Idea Generation 149 Testing 151 Summary 170 Note 171 Part three A Practical Guide for Investors in Quantitative Strategies Chapter 10 Risks Inherent to Quant Strategies 175 Model Risk 176 Regime Change Risk 180 Exogenous Shock Risk 184 Contagion, or Common Investor, Risk 186 How Quants Monitor Risk 193 Summary 195 Notes 195 Chapter 11 Criticisms of Quant Trading 197 Trading Is an Art, Not a Science 197 Quants Cause More Market Volatility by Underestimating Risk 199 Quants Cannot Handle Unusual Events or Rapid Changes in Market Conditions

rishi k narang is the Founding Principal of T2AM LLC, which invests in quantitative strategies. He has been involved in the hedge fund industry variously as an investor in and practitioner of quantitative trading strategies since 1996.

When he isn't working, Rishi enjoys playing his guitar, writing essays and poems, making pencil sketches, arguing with people, playing tennis, doing yoga, and hiking. Rishi completed his undergraduate degree in economics at the University of California at Berkeley. He lives in Los Angeles with his wife, Dr. Carolyn Wong, and their son, Solomon.