1. Black Monday “Short Circuits”
More to it than program trading?
Black Monday “Short Circuits”
Yonsei GSIS
Int’l Trade & Finance
Ryan

2. Contents
What happened on Oct 19th 1987?
Why?
Lessons

3. Originated from US?
Largest one-day percentage decline in stock market history
began in HK, spread west to Europe, hitting the US
The crash began in Hong Kong, spread west through international time zones to Europe, hitting the United States after other markets had already declined by a significant margin.
(DJIA) dropped by 508 points to 1739 (22.6%).
By the end of October, stock markets in Hong Kong had fallen 45.8%, Australia 41.8%, Spain 31%, the United Kingdom 26.4%, the United States 22.68%, and Canada 22.5%. New Zealand's market was hit especially hard, falling about 60% from its 1987 peak, and taking several years to recover.

4. Why? – no conclusion reached
Program trading - article’s thought
Index arbitrage & portfolio insurance
Macroeconomic reasons
F/X , I/R, fears about Inflation

5. Program trading – internal reasons
"Program trading was the principal cause.” ? - Edward J.Markey
computers perform rapid stock
executions based on external inputs .

6. Index arbitrage - strategy of Program trading
different rules about when to stop trading
Chicago (CBOE, CME) stopped trading
NY (DJI) didn’t stopped trading
Two worst worlds
Illiquidity in stock market
Rush to futures market to hedge their positions by selling stock-index contracts

7. Portfolio insurance -strategy of Program trading
Similar to Protective put
stock + “synthetic” put
Adv
same P/L as the traded put
no need to resort to option market
Drawbacks
provide no signal to the market.
No preparation for illiquidity
And counterarguments…

8. Macroeconomic reasons
Dispute in monetary policy between G7
Fear of inflation
Tighten monetary policy faster than European
Illiquidity caused $ - backed HK stock to collapse .

9. Lessons - article They need to be “coordinated”
If trading is halted, it must be halted in every market- cash, futures, and options.
Otherwise, this connected market is capricious and unfair.

10. Are we rational? Assumptions brought into question
Human rationality
Efficient market hypothesis
Economic equilibrium
Development of behavioral finance
Overconfidence, anchoring, representativeness, Aversion to ambiguity, frame dependence
Adaptive behavioral economics
Learn from crisis !