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SHILLER: Most people got the cause of Black Monday's stock market crash wrong

  • Right after the stock market crashed on Oct. 19, 1987, Robert Shiller sent investors a questionnaire to figure out what caused it.
  • His research showed that trader panic was as culpable as the computer programs that worsened the crash, contrary to the government and many traders’ conclusions.
  • The same panic can happen again, Shiller wrote in the New York Times, and new technology can spread fear even faster.

On the 30th anniversary of Black Monday, the Nobel prize-winning author Robert Shiller is reiterating his view of what really happened.

Writing in the New York Times on Thursday, Shiller argued that the Dow’s 22% plunge — its worst ever — was caused primarily by mass investor panic, not the computers they had set up to trade stocks. His conclusion is that this behaviour could happen again.

Shiller highlighted research he published in November 1987, which contradicted the Reagan administration’s conclusion. The government’s Brady Commission said the crash was primarily caused by mutual funds meeting redemption orders, and institutional investors who used portfolio insurance — a program that systematically sold equity futures as the prices fell.

“Ultimately, I believe we need to focus on the people who adopted the technology and who really drove prices down, not on the computers,” Shiller wrote in the Times. He continued: “In reality, my own survey showed, traditional stop-loss orders actually were reported to have been used by twice as many institutional investors as the more trendy portfolio insurance.”

In other words, Shiller’s survey of investors showed that losses accelerated as traders panicked while watching the market fall; price declines led to more deliberate selling.

In his research paper, Shiller further argued that since portfolio insurance had been used before Black Monday, other factors must have been responsible for a crash of that magnitude.

He noted that a few issues were already on investors’ minds, including concerns that stocks were overpriced, comparisons to the October 1929 crash, also known as Black Tuesday.

Shiller’s research paper concluded (emphasis added):

The actual decision to buy or sell on October 19 seems to be only weakly related to interpretations of recent news events that investors rated as important: there was little difference between buyers and sellers on the importance rating that was given to news events. Respondents apparently did not have a clear theory how these past news events translated into predictions of market price movements on October 19, yet very many respondents still had predictions. It would thus be wrong to say, as many have done, that the market drop on October 19, 1987 ought to be interpreted as a statement of public opinion about some fundamental economic factor, e.g., that there is lack of confidence in the White House or Congress. At best, any such opinions probably played a role in the crash mainly as they affected the vague intuitive assessments people under great stress made about the tendency of prices to continue or reverse, or about how other investors will react to the current situation.

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