Aurora Borealis
1 September 1988 Financial Analysts Journal Volume 44, Issue 5

The International Crash of October 1987

  1. Richard Roll

All major world markets declined substantially in October 1987—an exceptional occurrence, given the usual modest correlations of returns across countries. Of 23 markets, 19 declined more than 20 per cent. The U.S. market had the fifth smallest decline in local-currency units, but came in only 11th out of 23 when returns are restated in a common currency.

The U.S. market was not the first to decline sharply. Non-Japanese Asian markets began a severe decline on October 19 (their time). This decline was echoed first by a number of European markets, then by North America and, finally, by Japan. Most of these same markets, however, had experienced significant but less severe declines in the latter part of the previous week. With the exception of the U.S. and Canada, markets continued downward through the end of October, and some of the declines were as large as the great crash on October 19.

Various institutional characteristics have been blamed as contributors to the crash. Univariate regressions indicate that the presence of an official specialist, computer-directed trading, price limits and margin requirements were associated with less severe stock market declines in October 1987, while continuous auctions and automated quotations were associated with larger declines. In multiple regressions, however, several of these variables, including price limits and margin requirements, were found to be insignificant.

October’s crash could be ascribed to the normal response of each country’s stock market to a worldwide market movement. A world market index was found to be statistically related to monthly returns in every country during the period from the beginning of 1981 up until the month before the crash. The magnitude of market response differed materially across countries. The response coefficient, or beta, was by far the most statistically significant explanatory variable in the October crash, swamping the influences of the institutional market characteristics. Only one institutional variable—continuous auctions—had even a marginally significant influence on the estimated beta.

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