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On October 19, 1987, a bizarre and completely unprecedented set of events unfolded in America's financial markets. In New York, the brokerage firm Donaldson, Lufkin & Jenrette posted uniformed security [...]

Byline: Richard R. Lindsey (1), Anthony P. Pecora (2) Abstract: It has been approximately 10 years since uncertainty, panic, and confusion wrested control from the forces of supply and demand and sent the U.S. securities markets plummeting. After much review, discussion, and analysis, it is widely agreed that certain aspects of the financial system contributed to that event. Since October 1987, many reforms have been implemented to address the weaknesses in the system highlighted by the 1987 market break. They include, among others, the implementation of circuit breakers, the approval of the Order Execution Rules, the reduction of the standard settlement time frame to T+3, the conversion to a same-day funds settlement system, the initiation of programs that regularly test the capacity of the market's automated systems, the augmentation of firms' capital levels, and improved coordination with regulators in other countries. The market has improved significantly because these changes have reduced or eliminated risk by improving coordination, increasing efficiency, sharing information, or ensuring sufficient system or capital capacity exists. Nevertheless, every market event is unique. Therefore, it remains important to identify and address new issues before they become problems. Author Affiliation: (1) Division of Market Regulation, U.S. Securities and Exchange Commission*, USA (2) Division of Market Regulation, U.S. Securities and Exchange Commission*, USA Article History: Registration Date: 13/10/2004

A study of the linkages between S & P 500 index futures market and the S & P stock index futures prices in October 1987 reveals that, except for Oct 16 and 19 1987, the two markets were highly cointegrated and ran as one market for the majority of the trading days for the said month. The results of the study likewise indicate that the stock and futures markets met instantly following the crash. The price-discover process also came from the futures market rather than from the stock market, as the two markets are connected by index arbitrage.

Debt-deflation can occur due to falling asset prices, financial crisis, debt repayment difficulties, or the interdependency of the financial system. This is opposed to Irving Fisher's debt-deflation theory which avers that a drop in commodity prices increases the debt burden of borrowers. The 1987 stock market crash exemplifies this modern theory. Government bailouts of the financial system and lender-of-the-last-resort intervention help in aborting debt-deflations since lenders have a crucial role to play.

The existence of a causal relationship between stock markets in Hong Kong, Japan and Singapore is investigated using state space modeling. Results show that the Japanese stock market influenced the performance of other Asian stock markets during the international stock market crash of Oct. 1987. It is also shown that the relationships between Asian stock markets increased following the crash.

Two of several theories of the 1987 stock market crash are the cascading scenario and Leland's backward-bending demand curve theory. This paper shows that previous descriptions of the cascading scenario are incomplete and that the logical completion of the scenario leads to Leland's backward-bending demand curve. Therefore, whether the cascading scenario led to the crash depends primarily on whether the demand curve for stock or stock equivalents was backward bending., Explanations of the 1987 crash initially blamed the market's institutional structure and practices such as program trading, futures, and portfolio insurance. These explanations include the cascading scenario,(1) the Brady Commission [...]

This study examines the behavior of a small stock market with circuit breakers and with a one-hour preauction order imbalance disclosure, during the October 1987 crash. The crash and its aftershocks lasted for a week and selling pressure was concentrated in higher beta, larger capitalization, and lower leverage firm stocks. Circuit breakers when implemented reduced the next-day opening order imbalance and the initial price loss; however, they had no effect on the long-run response. Some price overreaction and reversal phenomena also are documented. (Reprinted by permission of the publisher.)

Following the crash of 1987, one contentious regulatory issue has been whether margin activity exacerbated the decline in equity values. We contrast the crash behavior of NASDAQ securities eligible for margin trading with the behavior of ineligible ones. Consistent with the hypothesis that margin-eligible securities were more frequently subjected to margin calls and forced sales, we find that abnormal volumes were uniformly larger for eligible securities. However, there is no evidence that this activity provoked additional price depreciation. Margin-eligible securities actually fell by one percent less than the ineligible securities over the period., Following the crash of 1987, one contentious regulatory issue has been whether margin activity exacerbated the decline in equity values. We contrast the crash behavior of NASDAQ securities eligible for margin trading with the behavior of ineligible ones. Consistent with the hypothesis that margin-eligible securities were more frequently subjected to margin calls and forced sales, we find that abnormal volumes were uniformly larger for eligible securities. However, there is no evidence that this activity provoked additional price depreciation. Margin-eligible securities actually fell by one percent less than the ineligible securities over the period. (Reprinted by permission of the publisher.)

The volatility of a stock market is usually been attributed to short-term price pressure resulting from futures-based trading strategies. Intraday price volatility of stocks included in the Standard and Poor's 500 Index or Major Market Index were compared with the price volatility of non-index stocks in days which had price pressures similar to Oct 1987. Results indicate that price volatility for index stocks did not differ from price volatility of non-index stocks.

A multiplier-analysis model was used to develop a time series model that would describe and predict the consequences of the New York City stock market crash in 1987. Results show that a pervasive change in the structure of New York City's securities industry has resulted. The loss of 24,900 jobs and indications of a further 90,000 projected decline demonstrates the effect industry adjustments on a national or international scale can affecct local governments.

We provide new evidence regarding the degree of integration among markets for stocks, futures and options prior to and during the October 1987 market crash. Where previous analyses have resulted in recommendations for the implementation of circuit breakers, the coordination of margin requirements across markets, and changes in regulatory jurisdiction, our analysis indicates that delinkage between markets during the crash was primarily caused by an antiquated mechanism for processing stock market orders. The results suggest that market integration may be better served by efficient order execution than by further restricting markets. To a large extent, the problems of mid-October can be traced to the failure of these market segments stocks, stock index futures, and stock options to act as one. (Report of the Presidential Task Force Brady Report (1988, Executive Summary, p. vi))., We provide new evidence regarding the degree of integration among markets for stocks, futures and options prior to and during the October 1987 market crash. Where previous analyses have resulted in recommendations for the implementation of circuit breakers, the coordination of margin requirements across markets, and changes in regulatory jurisdiction, our analysis indicates that delinkage between markets during the crash was primarily caused by an antiquated mechanism for processing stock market orders. The results suggest that market integration may be better served by efficient order execution than by further restricting markets. (Reprinted by permission of the publisher.)

After-hours pricing in foreign equity markets of multiple-listed U.S. securities appeared to be efficient in predicting New York prices in the weeks immediately following the October 1987 crash but relatively uninformative in succeeding months. By contrast, daily changes in New York prices appear to be efficiently incorporated in after-hours trading on both the Tokyo and London exchanges throughout the sample period. This paper suggests that the asymmetry and temporal variations in cross-market correlations are consistent with rational investor behavior in equity markets with nonzero transaction costs and time-varying share price volatility. (Reprinted by permission of the publisher.)

This paper shows that (i) the Crash was a surprise to corporate insiders; (ii) insiders became buyers of stock in record numbers immediately following the Crash; (iii) stocks that declined more during the Crash were also purchased more by insiders; and (iv) stocks that were purchased more extensively by insiders during October 1987 showed larger positive returns in 1988. The overall evidence suggests that overreaction was an important part of the Crash. (Reprinted by permission of the publisher.)

The subprime loans crisis which affected the United States has also affected countries in Europe and even Asia. The Black Monday or the Stock Market Crash of 1987 was compared to the recent financial crisis. Details of the economic conditions of Japan and the financial crisis that hit its economy are discussed.

To develop improvements in the stock market mechanism which would help prevent another 'market break,' it is important to understand the structure of the mechanism for stock market trading. Market makers and index arbitragers are only intermediaries between the patient and impatient traders who ultimately determine prices. Institutions for maintaining trust based upon accountability to customers in securities trading are scarce. The events of October 1987 unfolded as two distinct sets of events: a crash in which impatient sellers overwhelmed patient buyers, and a panic in which solvency worries took traders out of the markets. Proposals to improve the stock market mechanism should address the proper role of market makers, the lack of accountability of the mechanism to customers, and the differences between panics and crashes. (Reprinted by permission of the publisher.)

Portfolio insurance is a hedging technique that allows the maximum exposure to high-return assets while providing reasonable assurance that a prespecified minimum return will be achieved. While it is true that the chaotic market conditions of October 19th made portfolio insurance more costly than normal, it still provided substantial protection. Portfolio insurance did not significantly contribute to the decline of stock prices on October 19th, rather the magnitude of the market fall was due to insufficient liquidity. Portfolio insurance and other dynamic strategies continue to have a legitimate role to play in helping investors realize their objectives. (Reprinted by permission of the publisher.)