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Cause Of The Crash In Stock Market

2367 words - 9 pages

1. Introduction1.1 Black MondayThe 1987 stock market crash stands out as one of the most remarkable financial events of the 20th century, perhaps since the emergence of our capitalist system several centuries ago. What makes it remarkable is:1) The historic extent to which markets fell, an unprecedented 23%, and that they did so all over the world.2) Its suddenness, how it appeared out of nowhere, and only took one day to play itself out.3) Its complete lack of explanation. To this day no definite reason for the decline has been isolated. Basic concepts such as cause and effect, predictability, and human rationality melt before the evidence of the record breaking decline1.2 2001-2002 declineThis downturn can be viewed as part of a larger bear market or correction, after a decade-long bull market had led to unusually high stock valuations. The NASDAQ was trading at 4234.33 on September 1, 2000. From September of 2000 the NASDAQ dropped 45.9% to 2291.86 by Jan 02, 2001. In Oct. of 2002, the NASDAQ dropped as low as 1,108.49 which is 78.4% drop from its all-time high of 5,132.52 in Mar. of 2000. A total of 8 trillion dollars of wealth was lost in the market decline.2. Causes of the Crash in 1987So, what were the causes of the stock market crash of 1987? Many stock market analysts believe that the crash was set off by a number of events. Here I am providing five reasons that could be factors for the crash in 1987, including psychological cause, the poor choices of portfolio insurance professionals, program trading, derivative securities, and trade and budget deficits2.1 Psychological cause1) Why the 1987 crash occurred on Monday, October 19?In the historical model investors had adopted, the crash had occurred on a Monday in October, 1929. The overlap in Mondays resulted in a self-fulfilling prophecy to emerge in 1987.2) Why the move was so extreme in price?1987 fell 23% because participants noted that 1929 had fallen 24%.3) Why it fell so quickly?1929's 24% decline had only taken 2 days to occur. By analogy, market participants felt equities could fall as fast in 19874) Why 1987 was an international phenomenon?The 1929 crash set a precedent by affecting markets from Paris to London to New York. Thus investors the world over were influenced by the memory of the crash and Great Depression, not just those in the U.S., and were willing to sell in 1987 using the 1929 memory as justification.5) How a lack of major news or important events prior to the decline could justify a 22% change?The cause was psychological, caused by an old memory. Thus, it needed no events or important news to emerge.2.2 Portfolio InsuranceThe poor choices of portfolio insurance professionals also resulted in the crash. A portfolio is a collection of stocks. Portfolio insurance, a form of investment, is the guarding of other stock investments against losses. This is regarded as a highly risky way of investing in the stock market because these portfolio insurance professionals rely...

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