The 1987 market crash: 20 years later

Citation

Glenn Baigent, G. and Massaro, V.G. (2009), "The 1987 market crash: 20 years later", Review of Accounting and Finance, Vol. 8 No. 2. https://doi.org/10.1108/raf.2009.28508baa.001

The 1987 market crash: 20 years later

Article Type: Introduction From: Review of Accounting and Finance, Volume 8, Issue 2.

Society relies on well-functioning capital markets to promote economic progress in businesses and households. To that goal, academics argue that capital markets should provide for price discovery and liquidity, where the best way to find out what an asset is worth is to attempt to sell it. As long as there are a large number of market participants, bidding among them leads to price discovery, and an asset is sold quickly resulting in liquidity. Moreover, in a well functioning market the price should be close to its intrinsic value. But academic assumptions aside, is it not the case that institutional and private investors have the same expectations of our secondary markets?

For both institutional and private investors, capital markets are the domicile of our wealth. Capital markets reflect the performance of individual firms and the investment choices they make on behalf of shareholders. Markets reflect the value of retirement accounts such as 401 ks, 403 bs, or RRSPs in Canada. On a macro scale, capital markets are an indicator of the expectations of future earnings. The well-being of capital markets is of critical importance to all, even the US Treasury Department and Social Security.

Having turned the generational clock in 2007, it seemed appropriate to revisit the events of 1987. The literature seemed to be mixed as to the cause of the 1987 crash, new streams of literature such as behavioral finance have evolved, and many structural changes have occurred. Ironically, while all of the article reviews for this issue were in progress, the factors which cause market crashes or corrections became more important because we were witnessing a capital markets crisis in 2008. In most cases the authors had the difficulty of drawing their analyses to a close because each day there was more to add to the literature. But here we are, and we must conclude. There is a confluence to the articles in this edition – each in some way speaks to the issue of efficient capital markets.

McKeon and Netter have provided an extension to earlier work by Mitchell and Netter (1989). The current research reinforces the view (espoused in the 1989 paper) that relevant news caused the market crash in 1987, but they find that significant changes in market movements and volatility are associated with the market correction in 2008.

The “something is different now” theme is continued by Booth and Cleary. They report that significant structural changes have occurred in the Canadian economy since 1987. Their analysis documents macroeconomic changes and speaks to the impact of fiscal policy and monetary policy on the resilience of the Canadian economy, which they describe as more resilient today than in 1987.

Ang and Boyer examine an issue that was critical in 1987 – IPOs. They show that the 1987 market crash changed the psyche of the IPO market as evidenced by fewer IPOs from riskier firms. Following the crash, they find more rational pricing in the context of smaller discounts and smaller mean reversion. Clearly, this speaks to a behavioral component in asset prices. Let's hope that the current crisis leads to more rational pricing.

The behavior of investors is continued by Baigent and Massaro who suggest that the existence of portfolio insurance can create more aggressive trading and a moral hazard problem. Lending relevance to the 2008 crisis, the notional value of derivative securities has increased from $1T in 1987 to $542T, about 37 times the GDP of the USA The findings suggest that researchers re-examine the role of derivative securities, especially since there seems to be a symbiotic relationship between derivative and asset prices instead of one being causal.

Lastly, there have been significant regulatory changes in the capital markets since 1987 as documented by Kalbers. To the point, regulations are intended to provide for more accurate accounting information, but Kalbers opines that regulation occurs after the damage has occurred.

In the mid 1960s Eugene Fama formulated the efficient market hypothesis in which markets reflect all relevant information. The problem seems to be the information, not the markets.

G. Glenn Baigent and Vincent G. MassaroGuest Editors