What Caused the 1987 Stock Market Crash and Lessons for the 2008 Crash

We review an explanation for the causes of the stock market crash in 1987, update the empirical support for that argument, and compare to recent market developments. While the market crash on October 19, 1987 was the largest one-day Samp;P 500 drop in percentage terms in history (20.47%) there was also a large market drop (10.12%) in the three trading days before the 1987 crash. Mitchell and Netter (1989) show that the three-day decline was the largest in more than 40 years, large enough that the drop was news itself (the October 16, 1987 drop immediately before the crash was also an extremely large one-day decline). The theoretical model of Jacklin, Kleidon, and Pfleiderer (1992) shows how a surprise significant drop in the market could have provided information to the market that could directly lead to an immediate crash. Here we follow the stock market for 20 years after 1987, and find the magnitude of the market decline immediately preceding October 19, 1987 was still a significant outlier - only one three-day period in the 20 years after 1987 had as large a market decline. We also document the large market movements and volatility in the period beginning in October 2008 and suggest that this quot;crashquot; is different than what occurred in 1987. The 1987 crash was due in part to characteristics news but also of the market and trading strategy, 2008 is more likely a response to fundamental economic news