The 1987 Crash

Summary

The video explains the 1987 stock market crash, also known as Black Monday, highlighting its global impact and aftermath. The crash triggered significant losses in markets worldwide, with the US market experiencing a rapid sell-off and Japan avoiding the worst of it. While most markets recovered in the following years, New Zealand faced prolonged losses. The crash led to regulatory changes, including circuit breakers and heightened market scrutiny. It also influenced traders' understanding of volatility and market behavior, with figures like Nicholas Nassim Taleb gaining prominence for their insights on unpredictable market movements. Despite the panic, the S&P 500 finished 1987 slightly up.

Takeaways

• 😀 The 1987 stock market crash, known as Black Monday, had a significant global impact, affecting markets in Asia, Australia, Britain, and beyond.
• 😀 While the crash caused a brief panic in many markets, the New York market didn't exceed the initial lows set during the sell-off.
• 😀 Japan's stock market experienced a short-term panic but recovered quickly due to government intervention from the Ministry of Finance and aggressive buying by large financial institutions.
• 😀 New Zealand's stock market was hit particularly hard, continuing to decline long after other markets had started to recover, eventually losing 60% of its value by February 1988.
• 😀 Despite the crash, global markets began recovering after the event, with US stock prices rising an average of 14.7% annually over the next five years.
• 😀 The UK and European markets also saw positive returns post-crash, with annual gains of 7.6% and 8%, respectively.
• 😀 Japan, however, experienced a long-term decline after initially avoiding the worst of the crash, with an average annual loss of 7.2% over the following five years.
• 😀 Key regulatory changes were implemented after the crash, including circuit breakers to halt trading during large price declines, giving markets time to stabilize.
• 😀 Risk management strategies and trading patterns evolved, with a notable shift in implied volatility patterns used in financial options pricing after the crash.
• 😀 The crash also had a profound psychological impact on traders, leading to increased awareness of how volatile market moves can be, and it became the basis for the career of Nicholas Nassim Taleb, who later became known for his writings on market unpredictability.

Q & A

What was the primary cause of the 1987 stock market crash?

The 1987 stock market crash, known as Black Monday, was caused by a combination of factors, including automated trading programs, overvaluation of stocks, and investor panic. The crash occurred after a prolonged period of speculative investments and market volatility.

How did the global stock markets react to the 1987 crash?

Global stock markets experienced significant declines, with many hitting new lows. However, the New York market did not fall below the levels set in the initial selling climax. Japan's market was an outlier, as it seemed to avoid the worst of the collapse.

What happened in Japan's stock market after the 1987 crash?

After the initial panic on October 20, 1987, Japan's stock market saw a rapid recovery, thanks to intervention from the Ministry of Finance. Large financial institutions aggressively bought stocks, and the market rebounded, recovering much of its previous losses.

Why did New Zealand's stock market suffer more than others after the 1987 crash?

New Zealand's stock market faced a prolonged decline well after other global markets had recovered. The market initially fell nearly 15% on the first day, but it continued to decline, eventually losing 60% of its value by February 1988.

How did the stock markets recover after the 1987 crash?

The markets recovered over the following years, with the US market growing by an average of 14.7% per year, European markets rising by 7.6% annually, and the UK market seeing an 8% increase. Global stock markets, on average, grew by 6.3% annually.

What were the long-term effects of the 1987 crash on Japan's stock market?

Despite Japan's initial recovery, its stock market became the only major market to suffer long-term losses. From 1987 to 1990, Japan's stock prices declined by an average of 7.2% per year.

What regulatory changes were introduced following the 1987 crash?

In response to the crash, regulators introduced circuit breakers, which temporarily halted trading during periods of large price declines. This allowed traders to assess the market and respond more rationally. Additionally, trade-clearing protocols were standardized to improve market stability.

How did the 1987 crash affect trading strategies and risk management?

The crash led to significant changes in trading strategies, particularly in the pricing of financial options. Traders and risk managers learned to adapt to larger market fluctuations, with a noticeable shift in the implied volatility patterns used for pricing options.

What is the 'volatility smile' in financial options, and how did it change after the 1987 crash?

Before the 1987 crash, equity options did not exhibit a volatility smile, but after the crash, they began to show one. This change reflects the increased recognition of how volatile markets could be, leading to a revision in how options were priced.

What was the impact of the 1987 crash on market psychology and the careers of traders?

The 1987 crash had a profound effect on market psychology, with traders realizing the potential for much larger and more violent market moves than previously understood. One notable figure who emerged from the crash was Nicholas Nassim Taleb, a derivatives trader at the time who later became well-known for his work on the unpredictability of financial markets.