Wednesday, October 19, 2005

Markets and trust

Today is the anniversary of Black Monday, the worst single-day stock market crash in history:
On Monday, October 19, 1987, the Dow Jones Industrial Average declined 22.6% in the largest single-day drop in history.

This one day decline was not confined to the United States, but mirrored all over the world. By the end of October, Australia had fallen 41.8%, Canada 22.5%, Hong Kong 45.8%, and the United Kingdom 26.4%.
Black Monday, as it has become known, was almost twice as bad as the stock market crash of October 29, 1929. The 1929 decline approximated 11.7% and started the Great Depression.
Amazingly there is still debate as to what caused the crash:
A certain degree of mystery is associated with the 1987 crash. Many have noted that no major news or events occurred prior to the Monday of the crash, the decline seeming to have come from nowhere. Important assumptions concerning human rationality, the efficient market hypothesis, and economic equilibrium were brought into question by the event. Debate as to the cause of the crash still continues many years after the event, no firm conclusions having been reached.
Follow the link for some theories, which range from the apparently computer-related (Program trading) to the peculiarities of human nature (see, for instance, the Efficient market hypothesis and Behavioural finance). The unquantifiable aspects of the markets are underscored by the recent bankruptcy of Refco, an established, respectable and financially sound commodity trading firm:
Refco was a model 21st-century business—a highly digitized, high-tech services company that traded complicated financial instruments on behalf of customers all over the globe. But its meltdown shows that its real assets were not its New Economy algorithms and brainpower. Rather, this extremely modern company depended ultimately on the kind of assets that built American capitalism in the 19th century: trust, integrity, and the personal reputation of executives.
It is fascinating how in the apparently ever more impersonal modern world so much still depends on trust.

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