The Stock Market Crash of 1987

The Stock Market Crash of 1987

The stock market crash of 1987 was a seminal event for national and international stock markets. The crash of 1987 was the greatest on day decline in stock market values in American history. On October 19, 1987 the Dow Jones fell 22.6%. Measured by the S&P 500, the market fell 12.1% in October and 12.5% in November (Mishkin & White, 2002). This unprecedented crash was not only remarkable for its severity but also for the fact that it exposed the vulnerability of the trading system itself (Carlson, 2007).

One of the notable vulnerabilities of the trading system was the inability to access accurate information quickly. Uncertainty and lack of reliable information contributed to the pull back of investors which set of a cascade of events in which it became clear that the trading systems were not capable of handling the multitude of transactions at once (Carlson, 2007). Furthermore, Amihud, Mendelson, and Wood (1990) identified record margin calls and the timing of payments reduced market liquidity and led to a panic among investors.

Finally, as Choudhry (1996) has implicated program trading and overvaluation as possible causes of the market crash of 1987. Today, it is widely believed that a mixture of various factors have led to the market crash.

Response of the Federal Reserve

The Federal Reserve warily observed the events of October 19, 1987 and its immediate effect on markets in the United States and worldwide. Several researchers have noted that the Federal Reserve’s actions in response to the crash were highly visible and have thus contributed to easing the markets (Carlson, 2007; Mishkin & White, 2002).

One of the strategies employed by the Federal Reserve was to provide liquidity support. The Federal Reserve eased short-term credit conditions and thus allowing the market to absorb more liquidity. To achieve this