Tài liệu Review of Accounting and Finance Volume 8 ppt

Review of Accounting
and Finance
The 1987 market crash: 20 years
later
Guest Editors: G. Glenn Baigent and
Vincent G. Massaro
Volume 8 Number 2 2009
ISSN 1475-7702
www.emeraldinsight.com
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Access this journal online _______________________________ 119
Editorial advisory board _________________________________ 120
Introduction: the 1987 market crash:
20 years later _____________________________________
121
What caused the 1987 stock market crash and
lessons for the 2008 crash
Ryan McKeon and Jeffry Netter____________________________________ 123
Has the 1987 crash changed the psyche
of the stock market? The evidence from
initial public offerings
James Ang and Carol Boyer_______________________________________ 138
Capital market developments in the
post-October 1987 period:
a Canadian perspective
Laurence Booth and Sean Cleary___________________________________ 155
Review of Accounting and
Finance
The 1987 market crash: 20 years later
Guest Editors
G. Glenn Baigent and Vincent G. Massaro

ISSN 1475-7702
Volume 8
Number 2
2009
CONTENTS
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Revisiting derivative securities and the 1987 market
crash: lessons for 2009
G. Glenn Baigent and Vincent G. Massaro ___________________________ 176
Fraudulent financial reporting, corporate governance
and ethics: 1987-2007
Lawrence P. Kalbers _____________________________________________ 187
CONTENTS
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Review of Accounting and Finance
Vol. 8 No. 2, 2009
p. 120
# EmeraldGroup Publishing Limited
1475-7702
EDITORIAL ADVISORY BOARD
Ali Abdolmohammadi
Bentley College, USA
Pervaiz Alam
Kent State University, USA
Sharad Asthana
University of Texas at San Antonio, USA
Tim Cairney
Georgia Southern University, USA
Hsihui Chang
Drexel University, USA
Rong-Ruey Duh
National Taiwan University, Taiwan
Mahmud Ezzamel
Cardiff University, UK

Ehsan Feroz
University of Washington, Tacoma, USA
Liming Guan
University of Hawaii at Manoa, USA
Mahendra Gujarathi
Bentley College, USA
William Hopwood
Florida Atlantic University, USA
Marion Hutchinson
Queensland University of Technology, Australia
George Iatridis
University of Thessaly, Greece
Hoje Jo
Santa Clara University, USA
Laurie Krigman
Babson College, USA
Krishna Kumar
George Washington University, USA
Marc LeClere
Valparaiso University, USA
Joseph McCarthy
Bryant University, USA
Gordian Ndubizu
Drexel University, USA
Hector Perera
Macquarie University, Australia
Alan Reinstein
Wayne State University, USA
Herve
´

Stolowy
Group HEC (Hautes Etudes Com), France
Nikhil Varaiya
San Diego State University, USA
Huai Zhang
Nanyang Technological University, Singapore
Introduction
121
Review of Accounting and Finance
Vol. 8 No. 2, 2009
pp. 121-122
# Emerald Group Publishing Limited
1475-7702
Introduction: the 1987 market
crash: 20 years later
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 va lue. Bu t academic assumptions aside, is it not the case t hat i nstitutional
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 ex pectations 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 behavi oral 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 confl uence 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 pricin g 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
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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, regulatio ns are intended to provide for
more accurate accounting informati on, 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. Massaro
Guest Editors
What caused the
1987 stock
market crash
123
Review of Accounting and Finance
Vol. 8 No. 2, 2009
pp. 123-137
# Emerald Group Publishing Limited
1475-7702
DOI 10.1108/14757700910959475
What caused the 1987 stock
market crash and lessons for the
2008 crash
Ryan McKeon
School of Business Administration, University of San Diego, San Diego,

California, USA, and
Jeffry Netter
Terry College of Business, University of Georgia, Athens, Georgia, USA
Abstract
Purpose À The purpose of this paper is to review an explanation for the causes of the stock market
crash in 1987, update the empirical support for that argument, and compare to recent market
developments.
Design/methodology/approach À While the market crash on October 19, 1987 was the largest
one-day S&P 500 drop in percentage terms in history (20.47 percent) there was also a large market
drop (10.12 percent) in the three trading days before the 1987 crash. Previous research has shown
show that the three-day decline was the largest in more than 40 years, large enough that the drop was
news itself (the October 16, 1987 drop immediately before the crash was also an extremely large one-
day decline). The theoretical model of Jacklin et al. show how a surprise significant drop in the
market could have provided infor mation to the market that could directly lead to an immediate crash.
Findings À The paper follows the stock market for 20 years after 1987, and finds the magnitude of
the market decline immediately preceding October 19, 1987 was still a significant outlier À only one
three-day period in the 20 years after 1987 had as large a market dec line. The paper documents the
large market movements and volatility in the period beginning in fall 2008 and suggests that this
‘‘crash’’ is different than what occurred in 1987.
Research limitations/implications À This paper’s main limitations lie in the implications drawn
about the causes of the 2008 crash.
Practical implications À This paper provides evidence on the causes of the 1987 crash and
implications for the 2008 decline. The 1987 crash was due in part to characteristics news but also to the
market and trading strategy, the 2008 ‘‘crash’’ is more likely a response to fundamental economic news.
Originality/value À This paper uses empirical evidence since 1987 to look back on the causes of the
1987 crash.
Keywords Stock markets, Stock prices, Take-overs, Regulation, Financial modelling,
United States of America
Paper type Research paper
The cover story from the Newsweek (1987) issue that was released the weekend directly before

the October 19, 1987 crash was titled ‘‘Is the party over?’’ The second paragraph of the article
starts, ‘‘The cascading Dow and record trading volume marked a major shift in psychology
and sent a powerful shiver across the country’’ (Dentzer, et al., 1987).
1. Introduction
On Monday October 19, 1987, the US equity market suffered its largest single-day
percentage decline in history. The S&P 500 index fell by 57.86 points, a decline of 20.46
The current issue and full text archive of this journal is available at
www.emeraldinsight.com/1475-7702.htm
The authors would like to thank Glenn Baigent, Annette Poulsen, Janis Zaima, and a referee for
helpful comments and suggestions on the paper.
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percent. The Dow Jones Industrial average suffered a similar decline, falling by 508
points, 22.6 percen t of its value. The NASDAQ fell by 46 points, 11.35 percent of its
value (although many of the dealers stopped trading early, limiting the reported
decline). An important, but often forgotten, factor in this decline was the 10.12 percent
decline in the S&P 500 in the three trading days prior to October 19[1].
Mitchell and Netter (1989) argue that this three-day decline was an important
contributing factor to the crash À in fact, they describe the decline as a ‘‘trigger’’. In this
paper, we review this argument, provide simple descriptive evidence supporting the
argument and suggest how October 1987 is different from the market decline in late 2008.
We report data that the drop in the stock market immediately preceding the October 19,
1987 crash that others have shown was very large in historical terms remains one of the
largest declines over the next 20 years. Additionally, we document the unprecedented
level of volatility since August 2008 and show how it is different from 1987.
The October 19, 2007 market crash of mo re than 20 percent did not seem to be
related to any fundamental news. However, Mitc hell and Netter (1989) argue that the
three-day decline preceding the crash was a large enough dec line that it became the
fundamental news and that shook the market. The theoretical model of Jacklin et al.

(1992) (among others) shows how a surprise significant drop in the market could have
provided information to the market that would directly lead to a crash. In this paper, we
present evidence that even 20 years later, the magnitude of the market decline
immediately preceding the 1987 is still a significant outlier À only one three-day
period in the 20 years after 1987 had as large a market drop.
Jacklin et al.’s model suggests that the sharp market decline preceding the 1987
crash revealed the effects of new investment strategies by investors that had not been
fully anticipated by the market (they build on Grossman’s (1988) model of the effects of
imperfect information about por tfolio insurance). This revelation to investors of the
extent of dynamic hedging caused investors to dramatically revise downward their
stock valuations. Other explanations of the 1987 crash include liquidity problems (the
Presidential Task Force on Market Mechanisms (1988) À The Brady Report) in trading
when volume increased tremendously (perhaps as the result of portfolio insurance
trading), or changed investor psychology or some com bination of all the theories.
However, each of the theories is consistent with the effects of a large downward market
movement directly preceding the crash that was significant and unexpected, triggering
the October 19 crash.
The paper proceeds as follows. In section 2, we examine possible reasons for the
1987 crash, providing a general discussion on what causes large market movements,
and reviewing the Mitchell and Netter work on the 1987 crash. In section 3, we examin e
trading volume and market volatility since the 1987 crash, including the extraordinary
market events of the fall of 2008. We conclude in section 4.
2. Explanations for the October 1987 crash
There are at least three general views of the causes of the stock market crash on
October 19, 1987. The views are not mutually exclusive. One is the efficient market
story À the market reacted to some fundamental news that led market participants to
revalue stocks down by more than 20 percent in one day. A second is a liquidity
story À for some reason, probably a large number of sell orders, liquidity declined
significantly, de pressing prices. A third is some variant of a behavioral finance
story À investor s acting irrationally either drive prices up too high, followed by a

significant fall, or panic and sell for some reason, significantly depressing prices.
What caused the
1987 stock
market crash
125
2.1. Explanations of large market-wide stock-price movements
Cutler et al. (1989) analyze the question of what fundamentally causes lar ge s tock price
movements in a paper that followed s oon after the 1987 crash. Their general conclusion is
that we are not very good at explaining large stock price movements, questioning the
‘‘ efficiency’’ of the mar ket. They first consider the impact of macroeconomic news on the
stock market. The paper examines the relation of macroeconomic fundamentals as
dividend payments, industrial pr oduction, r eal money supply, long and short-term interest
rates, inflation and stock market volatility. They conclude that these macroeconomic
varia bles are not statistically meaningful in explaining stock market returns.
Cutler et al. also conduct a less formal analysis of the impact of ‘‘big news’’ on the
stock market. Using the World Almanac as a source of significant news stories, the paper
narrows its selection of ‘‘big news’’ to those stories which were featured on the front page
of the New York Times or were the lead story in the business section of the paper. Few if
any of the stock market returns on these days are comparable to the returns seen in
October 1987. The paper then reverses the analysis, examining the largest single-day
movements of the S&P 500 index and examining the New York Times for an explanation
of the event. The explanation they find for the October 19, 1987 crash is ‘‘Worry over
dollar decline and trade deficit; Fear of US not supporting the dollar’’.
Cutler et al. conclude that it is difficult to explain large price movements even after
the fact. An interpretation of their results is that if one cannot explain market
movements after the fact, when news has been revealed, and markets do not move
much in response to large news stories, it is difficult to argue that fundamentals drive
markets, at least in the time of extreme movements.
Haugen et al. (1991) perform a similar analysis, but focus on stock market volatility
rather than returns. The authors document the largest single day shifts in stock market

volatility and search for contributing explanations. When the authors are able to match
large increases in volatility with a well-documented event, the event tends to be an act
of warfare, a natural disaster or an assassination. The paper also notes that large
decreases in volatility can generally be matched to political enactments or
proclamations. This latter finding suggests a possible role for regulatory entities in
‘‘calming’’ markets during volatile times.
2.2. The cause of the market decline October 14-16, 1987
Mitchell and Netter (1989) provide a case study of one market movement in contrast to
the more general but less detailed analysis of Cutler et al. Mitchell and Netter provide
both cross-sectional and time series evidence supporting their hypothesis that the very
large October 14-16, 1987 market decline was due to an unexpected proposal in the
House Ways and Means Committee to end the tax deductibility of debt used in
takeovers. Noting that the October 14-16, 1987 period represented the largest one-, two-
and three-day declines (–5.16, À8.11 and À10.44 p ercent, respectively) since the French
army’s defensive position was unexpectedly com promised in May 1941, in WW II, the
paper examines the possible causes of this decline. The paper concludes that the
market reacted negatively to news that a bill ending the interest deductibility of debt in
takeovers was unexpectedly proposed by the US House Ways and Means Committee
and was likely to pass. Therefore, it was the prospect of this bill being signed into law
that may have caused the market decline of October 14-16, 1987, which then led to the
subsequent more drastic decline on Monday October 19.
On the night of October 13, 1987 the House Ways and Means Committee introduced
a tax bill that had several provisions designed to restrict takeovers, especially ending
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interest deductions on debt used to acquire over 20 percent of a target’s stoc k or assets.
Given the Democratic control of the House and Senate, there was a very real possibility
that the bill would pass. Mitchell and Netter identify five dates and precise times when
new information on the bill reached the market. The market reacted negatively when

the news of the bill progressing reached the market and positively when late in October
Congress backed off. In addition, the cross-sectional and microstructure movements
went in the predicted ways. All of their tests support the premise that the tax
legislation was key to the stock market decline in the three trading days before the
market crash. Further, they present evidence that it is unlikely that other news,
including the trade deficit, caused the decline.
Two other papers, Miller and Mitchell (1999) and Mitchell et al. (2007), examine in
more detail how the news about the tax could have caused a major decline in the
market. Miller and Mitchell (1999) examine whether fundamental news could
conceivably explain the market movements of October 1987 and show that fairly
modest changes in expected future cash flows o r discount rates can result in large
market revaluations. The authors state, ‘‘while it might first seem that one should be
able to identify the shocks to fundamental factors that can cause such a dramatic price
decline, the above analysis suggests that these shocks do not necessarily have to be
dramatic themselves’’. Mitchell et al. (2007) analyze how costly arbitrage mispricing
‘‘can be large and can extend for a long period’’. They consider several examples,
include the stock market crash. They show how the tax bill caused merger arbitragers
to sell on October 14, 1987 through October 16, 1987 and the selling increased on the
October 19 accelerating the price decline.
Roll (1989), however, argues that the international nature of the decline over the
weekend of October 17 and 18 is not consistent with the takeover-tax story. Mitchell
and Netter note however that the world decline occurred after the US decline and was
much smaller in magnitude (an equally weighted world index fell 2.03 percent).
Further, as we discuss below, the world movement may be consistent with the trigger
story told my Mitchell and Netter À the large three-day decline started the whole
market downward.
2.3 The effect of the market decline immediately before October 19, 1987
Grossman (1988) models a situation where the amount of dynamic hedging undertaken
by traders is not public knowledge unt il they trade on these strategies. When
coordinated selling occurred based on these strategies (e.g. during a big market decline)

liquidity issues will further depress the market. Grossman notes that if there were more
dynamic hedging strategies in place than anticipated by traders, traders might be
unable to execute all the dynamic hedging they had planned, increasing market
volatility. Jacklin et al. (1992) also address the situation where a market has
underestimated the amount of dynamic hedging strategies such as portfolio insurance,
and the true amount if the hedging is revealed. However, unlike Grossman they
concentrate on the effect the revelation of the information about the extent of dynamic
hedging will have on traders’ valuation of secu rities. In this case, the market will
decline to reflect the information that the market was overvalued. Jacklin et al. note the
large decline on October 16, 1987 fits with their model. While the liquidity problems
pointed out by the Brady Commission (1988) and Grossman played a role in the crash,
it is unlikely they were enough to cause the crash on their own.
What caused the
1987 stock
market crash
127
3. Large market movements since 1950
In this section we report on market movements and volatility since 1950, concentrating
on evidence post-1987. Our goal is two-fold. First, we provide new evidence that
supports the argument that the market drop in the trading period immediately before
the 1987 crash was an unusually large dec line. Second, we report recent evidence on the
unprecedented nature of the September–November 2008 ‘‘crash’’. Note here our single
most important piece of evidence (contained in Table IV) about the 1987 crash is that
the magnitude of the three-day decline immediately preceding the 1987 crash was
larger than any three-day decline in the 20 years after the 1987 crash.
The years since the market crash of October 1987 have served to further strengthen
the argument that the period from October 14-16, 1987 was an unusually large market
decline, which very likely then precipitated the crash on Monday, October 19, 1987.
While the 20 years since the crash have seen the volume of trading on the NYSE
increase dramatically, and while there have been episodes or days with large market

movements, the October 14-16, 1987 period still ranks high amongst periods of severe
market decline. While an argument can be made that the infrastructure of the market
has improved over the last 20 years so that the market is better able to cope with
episodes of high volume and illiquidity, it is also fair to say that the thre e-days
preceding Monday October 19, 1987 remain an extraordinary period of decline in the
history of the stock market. In this section we explore both of these issues: the volatility
and resiliency of the market since the crash, and the unusual nature of trading on
October 14-16, 1987, which immediately preceded the crash.
3.1 Volatility and volume
Table I reports the largest single-day negative returns for the S&P 500 index since
1950, over various intervals. This table concentrates on single day movements, not as
much a focus of Mitchell and Netter (1989) who concentrate on the three-day window
when tax news reached the market, but potentially related to the ‘‘trigger argument’’. In
the period from 1950 through July 30, 2008 October 16, 1987 still appears to have been a
very large decline. There are nine days (excluding October 19, 1987) on which the
market suffered a greater decrease than October 16, 1987. However, these decreases
were not followed by the kind of crash seen in October 1987. Indeed, with only one
exception, the market rebounded on the following days, as indicated in the table. The
story is different for the market conditions seen since August 1, 2008, when there are
ten days with a greater decline than the October 16, 1987 decline. We discuss this
period in greater detail in section 3.3.
Table II further illustrates this point. The Table highlights all t he single days since
1987 in which the market (as measured by the S&P500 Index) declined by 3 percent or
more. Note that in this table the period since the end of July 2008 is considered
separately. As of November 30, 2008, there had been 51 such negative-return days (less
than 3 percent), and 20 of these days have occurred since the beginning of August 2008.
Furthermore, there were 121 two-day periods between January 1988 and November 30,
2008, which saw a cumulative market return of À3 percent or less. The number of
three-day periods where the market fell by 3 percent or more during this same period is
216. In other words, the market has cer tainly seen significant swings since October

1987, but without generating another similar crash.
Notable features of the October 1987 market crash are the volume of trading and the
level of volatility exhibited by the market. Figure 1 illustrates the time series of daily
trading volume from January 1968 to December 1987. It illustrates the dramatic spike
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in volume of trading on October 19 and 20, 1987. On these two days the volume of
trading (as measured by number of shares traded) was 604,300,032 and 608,099,968,
respectively, far greater than the more usual range of 140 million to 180 million
exhibited for mos t of that year. Significantly, the days prior to the crash on Monday
October 19 also saw comparatively large volumes of trading. October 15 and 16, 1987
saw volume re ach 263,200,000 and 338,500,000 shares, respectively. Nothing prior to
October 1987 even comes close to matching the volume on these two days.
The unusually high levels of trading in October 1987 are again illustrated in Figures
2 and 3, which use October 1987 as a starting point and chart the daily volume of
trading in S&P 50 0 stocks until November 30, 2008. Although there is a clear upward
Table I.
Largest single-day
negative S&P 500
returns ( January 1,
1950-November 31, 2008)
Date Return Return
(tþ1) (%)
Return
(tþ2) (%)
Return
(tþ3) (%)
January 1, 1950-July 30, 2008
19-October-87 À20.47 5.33 9.10 À3.92

26-October-87 À8.28 2.42 0.04 4.93
27-October-97 À6.87 5.12 À0.29 À1.68
8-January-88 À6.77 1.68 À0.84 0.16
28-May-62 À6.68 4.65 2.67 À0.42
26-September-55 À6.62 2.28 1.68 À0.63
13-October-89 À6.12 2.76 À0.49 0.18
14-April-00 À5.83 3.31 2.87 À0.98
26-June-50 À5.38 À1.10 1.12 À3.70
16-October-87 À5.16 À20.47 5.33 9.10
17-September-01 À4.92 À0.58 À1.61 À3.11
11-September-86 À4.81 À1.92 0.55 À0.09
14-April-88 À4.36 0.01 À0.22 À0.50
12-March-01 À4.32 1.48 À2.58 0.59
30-November-87 À4.18 0.74 0.62 À3.53
3-September-02 À4.15 1.75 À1.60 1.68
August 1, 2008-November 30, 2008
15-October-08 À9.04 4.25 À0.62 4.77
29-September-08 À8.79 5.42 À
0.45 À4.03
9-October-08 À7.62 À1.18 11.58 À
0.53
31-August-98 À6.80 3.86 À0.38 À0.83
20-November-08 À6.71 6.32 6.47 0.66
19-November-08 À6.12 À6.71 6.32 6.47
22-October-08 À6.10 1.26 À3.45 À3.18
7-October-08 À5.74 À1.13 À7.62 À1.18
5-November-08 À5.27 À5.03 2.89 À1.27
12-November-08 À5.19 6.92 À4.17 À2.58
6-November-08 À5.03 2.89 À1.27 À2.20
17-September-08 À4.71 4.33 4.03 À3.82

15-September-08 À4.71 1.75 À4.71 4.33
Notes: This table reports the largest single-day decreases for the S&P 500 index, and the
performance of the index over the subsequent three-days; Date is the trading day; Return is the
trading day return based on the closing level the previous trading day and the closing level on
the actual trading day; Return
(tþn)
is the trading day return n days after the original trading day;
The data are split into a Pre-August 2008 period, whic h covers the period from January 1st 1950
to July 30, 2008, and a Post-July 2008 period, which covers the period from August 1, 2008S to
November 30, 2008; October 19 and October 16, 1987 rank 1st and 11th, respectively on the
Pre-August 2008 list
What caused the
1987 stock
market crash
129
Table II.
Days post-1987 in which
the S&P 500 index has
registered a decline of 3
percent or more
Date Volume One-day return (%)
November 1, 1987 - July 30, 2008
27-October-97 693,729,984 À6.8657
31-August-98 917,500,032 À6.8014
8-January-88 197,300,000 À6.7683
13-October-89 251,170,000 À6.1172
14-April-00 1,279,699,968 À5.8278
17-September-01 2,330,830,080 À4.9216
14-April-88 211,810,000 À4.3560
12-March-01 1,228,999,936 À4.3181

3-September-02 1,289,799,936 À4.1536
27-August-98 938,600,000 À3.8370
19-July-02 2,654,099,968 À3.8352
4-January-00 1,009,000,000 À3.8345
15-November-91 239,690,000 À3.6586
4-August-98 852,600,000 À3.6245
24-March-03 1,292,999,936 À3.5231
27-February-07 4,065,230,000 À3.4725
3-April-01 1,386,099,968 À3.4393
5-August-02 1,425,500,032 À3.4296
10-July-02 1,816,899,968 À3.3962
22-July-02 2,248,059,904 À3.2911
27-September-02 1,507,299,968 À3.2259
5-February-08 4,315,740,000 À3.1995
20-December-00 1,421,600,000 À3.1296
20-September-01 2,004,800,000 À3.1060
6-June-08 4,771,660,000 À3.0889
8-March-96 546,550,016 À3.0827
30-September-98 800,099,968 À3.0514
18-February-00 1,042,300,032 À3.0376
6-August-90 240,400,000 À3.0244
1-October-98 899,699,968 À3.0108
19-September-02 1,524,000,000 À3.0065
August, 12008-November 30, 2008
15-October-08 6,542,330,000 À9.0350
29-September-08 7,305,060,000 À
8.7897
9-October-08 6,819,000,000 À
7.6167
20-November-08 9,093,740,000 À6.7123

19-November-08 6,548,600,000 À6.1156
22-October-08 6,147,980,000 À6.1013
7-October-08 7,069,209,600 À5.7395
5-November-08 5,426,640,000 À5.2677
12-November-08 5,764,180,000 À5.1894
6-November-08 6,102,230,000 À5.0264
17-September-08 9,431,870,400 À4.7141
15-September-08 8,279,510,400 À4.7136
14-November-08 5,881,030,000 À4.1699
2-October-08 6,285,640,000 À4.0291
6-October-08 7,956,020,000 À3.8518
22-September-08 5,332,130,000 À3.8237
24-October-08 6,550,050,000 À3.4511
(continued)
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8,2
130
trend in the volume of trading over time, it was not until December 15, 1995 that
trading volume reached the single day level of October 19, 1987, and not until 1997 that
such daily volumes became common.
Since 1987, noticeable spikes in trading volume have been observed on several days:
.
January 4, 2001: volume reached 2,131,000,064 shares as the S&P retur ned À1.06
percent. This followed a relatively large rise in the market on January 3, 2001of
5.01 percent (volume of 1,880,70 0,032)
.
September 1, 1998: volume reached 1,216,600,064 shares as the S&P returned
3.86 percent. This followed a relatively large fall in the market on August 30 of
À6.80 percent (volume of 917,500,032).
.

October 28, 1997: volume reached 1,202,550,016 as the S&P returned 5.12
percent. This followed a relatively large drop in the market on October 27 of
À6.87 percent (volume of 693,729,984).
Table II.
Date Volume One-day return (%)
9-September-08 7,380,630,400 À3.4138
27-October-08 5,558,050,000 À3.1764
21-October-08 5,121,830,000 À3.0800
Notes: This table reports the details for each trading day on the S&P 500 since November 1,
1987 in which the return on that day was less than À3 percent; Date is the trading day; Volume
is the trading volume as number of shares traded; one day return is the return for the trading
day calculated from the previous trading day’s closing level to the actual trading day’s closing
level
Figure 1.
Daily volume of S&P 500
shares January 1, 1968 -
October 31, 1987
What caused the
1987 stock
market crash
131
.
August 16, 2007: volume reached 6,509,300,000 as the S&P returned 0.32 percent.
This followed a relatively large drop in the market on August 14 and 15 of À1.82
percent and À1.39 percent, respectively (volume of 3,814,630,000 and
4,290,930,000).
.
September 18, 2008: volume reached 10,082,689,600 as the S&P returned 4.33
percent. This followed a relatively large drop in the market on September 17 of
À4.71 percent (volume of 9,431,870,400 shares).

Figure 2.
Daily volume of S&P 500
shares October 1, 1987
September 30, 2001
Figure 3.
Daily volume of S&P 500
shares 1st October, 2001
November 30, 2008
RAF
8,2
132
These final cases show that four of the most noticeable spikes in volume during this
period came on the days after a large market decline. However, these volume spikes
were not associated with market declines themselves.
Figure 4 illustrates the monthly variance of the S&P 500, using daily-realized
returns to compute the measure. October 1987 stands out as the most volatile month of
trading during the period covered ( January 1950 to November 30, 2008). It is also
interesting to note that the second half of the 1990s saw increased levels of stock
market volatility, although no period has ever approached the level of October 1987.
Market volatility over the September–November 2008 period saw levels of volatility to
rival October 1987. Further discussion of this period follows in section 3.3.
Table III reports the most volatile months of trading in the S&P 500 since January
1950. October 1987 is the most volatile month of trading over this period, but all other
months except on e listed on the table have occurred since October 1987. Once again
this is an indication that the market has been comparatively volatile in periods since
October 1987, without producing the crash seen in 1987. Even so, prior to September
2008, no other month on this list had exhibited even half the level of volatility of
October 1987.
Events in September 2008 and since have produced a highly volatile market. The
week of September 15 to 19, 2008 saw firms such as Merrill Lynch, AIG and Lehman

Brothers reveal deep financial troubles within their operations. This followed the
revelation of severe financial difficulties for Fannie Mae and Freddie Mac, which saw
the Federal government promise taxpayer-funded assistance estimated to be as much
as $100 billion for each entity (Labaton and Andrews, 2008). The months of September,
October and November 2008 exhibited historic levels of volatility, even though they did
not eclipse October 1987. We will have more to say on the market volatility of these
three months in section 3.3.
Figure 4.
Monthly volatility, as
measured by SD of daily
close-to-c lose returns, of
the S&P 500 January
1950-November 2008
What caused the
1987 stock
market crash
133
3.2 October 14-16, 1987 in historical context: the following 20 years
Despite this evidence that the stock market has recently exhibited comparatively high
volatility and large single-day movements, Table IV illustrates how truly
extraordinary the market movements of October 14-16, 1987 were. Table IV first
reports the ten largest three-day cumulative decreases in the S&P 500 in the years after
October 1987, starting from November 1, 1987. Data for the three months starting at
the beginning of September 2008 is presented separately.
As reported in Mitchell and Netter (1989), the decline in the value of the stock
market between the October 14 and 16 was the largest three-day decrease since the
Second World War. Table IV illustrates that despite the recent increases in trading
volume and the relatively high levels of market volatility from 1997 to 2003, three-day
declines of similar magnitude were rare in the 20 years following the Crash. Only one
period, in late August 1998 outpaces the steep market decline of October 14-16, 1987.

The August 1998 period relates to the Russian default/Long Term Capital Management
crisis[2].
Prior to the October 1987 crash, three-day negative cumulative returns in the order
of magnitude of those documented above were rare. Periods of decline which rivaled
October 14-16, 1987 were largely confined to the Great Depression years of 1929-1933.
As reported in Mitchell and Netter (1989) the largest three-day decline in the stock
market prior to the 1987 crash occurred in May of 1940 ‘‘when German tanks broke
through the French armies, sealing France’s fate in World War II’’. We report in Table IV
the largest three-day declines since 1950, but before October 1987. No three-day decline
is as large as October 14-16, 1987, and only one three-day period listed in this table even
makes the top 10 list reported in the first set reported in Table IV (all dates up to
September 2008 ). Note we choose the three-day period because that was the period
chosen by Mitchell and Netter since it was the period after the first tax announcement
Table III.
Most volatile months of
trading in the S&P 500,
January 1950-November
2008
Month SD (%)
October 1987 5.73
October 2008 4.98
November 2008 4.36
September 2008 3.33
July 2002 2.66
January 1988 2.28
October 2002 2.24
September 2001 2.20
September 1998 2.19
October 1997 2.19
May 1962 2.13

August 2002 2.11
April 2000 2.11
August 1998 2.07
Notes: This table reports the most volatile months of trading in S&P 500 stocks since January
1950; the measure of volatility is standard deviation, calculated from daily realized close-to-close
returns from within the calendar month; Month is the relevant calendar month and SD is
calculated as:
P
T
t¼1
ðR
t
À RÞ
2
=T À 1, where t is the relevant trading day within the month, T is
the total number of trading days in the month, R
t
is the return on trading day t, as measured
from the previous day’s closing level to day t’s closing level, and R-bar is the average daily return
within the calendar month
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8,2
134
but before the crash. Their point is, illustrated with recent data in Table IV, that the
October 14-16, 1987 was very large, large enough the decline was major news itself,
and as discussed earlier may well had triggered the crash.
3.3 Market crisis in fall 2008
The evidence shows that the three trading days prior to the crash on Monday October
19, 1987 was a histo rically large market decline. This continues to be true even with 20
additional years of data since the 1987 crash studied by Mitchell and Netter (1989).

Table IV.
Largest three-day
declines in the S&P 500
post 1950 for various
periods compared to
October 14-16, 1987
Date Three-day cumulative return (%)
Largest three-day cumulative decreases in the S&P 500 since October 1987
1 November 1987-30 July 2008
27, 28, 31 August 1998 À11.71
14, 15, 16 Oct 1987 À10.12 Three trading days before
October 19, 1987
12, 13, 14 April 2000 À9.60
18, 19, 22 July 2002 À9.51
19, 22, 23 July 2002 À9.51
23, 24, 27 October 1997 À9.45
1, 2, 5 August 2002 À8.45
11, 12, 13 October 1989 À7.76
19, 20, 21 September 2001 À7.50
10, 17, 18 September 2001 À7.31
25, 27, 30 November 1987 À6.62
21, 22, 23 August 1990 À6.51
August 1, 2008-November 30, 2008
7, 8, 9 October 2008 À13.91
18, 19, 20 November 2008 À11.56
3, 6, 7 October 2008 À10.59
6, 7, 8 October 2008 À10.40
14, 15, 16 October 1987 À10.12 Three trading days before
October 19, 1987
8, 9, 10 October 2008 À9.74

2, 3, 6 October 2008 À8.97
10, 11, 12 November 2008 À8.45
22, 23, 24 October 2008 À8.20
21, 22, 23 October 2008 À7.84
17, 18, 19 November 2008 À7.64
Largest three-day cumulative decreases in the S&P 500 before October 1987
January 1, 1950-October 16, 1987
14, 15, 16 October 1987 À10.12 Three trading days before
October. 19, 1987
24, 25, 28 May 1962 À9.18
10, 11, 12 September 1986 À6.86
15, 18, 19 November 1974 À6.65
23, 26, 27 June 1950 À6.52
19, 20, 21 May 1970 À6.24
Notes: The findings report the largest three-day declines for different time periods, with the three
days prior to the October 19th 1987 crash serving as a benchmark; three-day decline is calculated
as: ð1 þ
R
tÀ2
ÞÂð1 þ R
tÀ1
ÞÂð1 þ R
t
ÞÀ1, where R
t
is the return on the S&P 500 on day t,as
measured from the previous day’s closing level to the day t closing level
What caused the
1987 stock
market crash

135
However, market conditions in late 2008 have seen market declines and volatility,
which rival, and in some cases su rpass, those of October 1987. In fact, the recent
market conditions only serve to confirm how extraordinary October 1987 was. Table I
includes August to November 2008 data for the largest single-day negative returns on
the S&P 500. Note especially two fact. First, there were a comparatively large number
of significant single-day market declines in the fall of 2008. Many days from August,
September, October and November would rank near the top of the list of largest single-
day negative returns on the S&P 500 since 1950. Secondly, none of these single-day
declines is of the magnitude of the Monday October 19, 1987 crash. Therefore, the one-
day data shows that the fall of 2008 was a par ticularly bad time for the market, but that
the one-day market crash of October 19, 1987 is still unique.
However, Table IV illustrates that the market crisis of fall 2008 has produced three-
day declines comparable to October 12-16, 1987. In particular, late August and the early
part of October 2008 saw three three-day declines larger than October 14-16, 1987, all in
a similar, over-lapping period. Specifically these periods were October 3-7, 6-8 and 7-9,
2008. The decline over the November 18-20 period was also noticeably large.
The months of August, September, October and November 2008 saw an unusually
high number of significant three-day declines. The magnitude of the decline over the
October 14-16, 1987 period is still historically high, however, even though it has since
be en joined by other comparable three-day declines. The fact that none of these more
recent three-day declines triggered a market cra sh similar to October 19, 1987
reinforces the notion that the market is now different to ho w it was back in 1987.
Table II provides evidence on just how volatile the market conditions of fall 2008
have been. In terms of day-to-day closing levels of the S&P 500, the volatility exhibited
in September, October and November 2008 are histo rically high. The standard
deviation (SD) of intra-month daily returns shows that these mo nths rank 4th, 2nd and
3rd, respectively on the list of most volatile months of trading in the market since
January 1950. However, importan tly, October 1987 still remains at the top of the list as
the most volatile month of trading in the market since 1950.

The market crisis of 2008 has cle arly led to sustained levels of high market
volatility, as shown by the high ranking of all months in this period on Table II. To
some extent this was also true of the 1987 crash. The subsequent months in 1987 also
saw comparatively high levels of volatility, although not on the same scale as
September–November 2008. November 1987, December 1987 and January 1988 saw the
following levels of intra-month volatility: 1.84, 1.77 and 2.18 percent, respectively.
These levels would rank 20th, 23rd and 9th on the updated post-1950 list of monthly
volatility. After October 1987, February 1988 saw a return to less volatility; it’s level of
0.99 percent ranks 160th. It remains to be seen what will happen to the market in this
current crisis.
4. Conclusion
In this paper we use the 20 ye ars since the market crash of October 1987 to further
strengthen the argument that the period immediately before the crash (October 14-16)
period saw an unusually large market decline. We review the arguments that this initial
market decline of October 14-16 precipitated the crash on Mond ay, October 19. We
argue that the news of the large three-day drop from the October 14 to October 16 led to
the crash on October19.
Mitchell and Netter (1989) perform a detailed case study analysis of the causes of
the market decline from October 14 to16. They argue that while several factors matter,
RAF
8,2
136
the most important was a proposed tax bill that would have sharply restricted the
takeover market by, among other things, ending the interest deductibility of debt used
in takeovers.
There are several theories on how the large three-day decline could lead to a crash
on the next trading day (October 19). They center on the idea that either a significant
decline revealed negative information about the market, led to liquidity problems in
trading, or changed investor psychology. However, the theories rest to some extent on
the premise that the downward market movement was significant and unexpected.

Critical to all the theories is that the decline of over 10 percent in the three-days
before the crash was very unusual. Mitchell and Netter note it was the biggest one-,
two-, or three-day decline since the unexpected victory of Germany over France in WW
II. Here we examine the 20 years since and find that the market decline the week before
the crash was indeed an unusually large decline in market history.
While the 20 years since the crash have seen the volume of trading on the NYSE
increase dramatically, and while there have been episodes or days with large market
movements, the October 14-16, 1987 period still ranks high amongst periods of severe
market decline. While an argument can be made that the infrastructure of the market
has improved over the last 20 years so that the market is better able to cope with
episodes of high volume and illiquidity, it is also fair to say that the thre e-days
preceding Monday October 19, 1987 remain an extraordinary period of decline in the
history of the stock market.
Finally, we suggest that the 1987 October Crash was caused by fundamentally
different dynamics than the fall 2008 market decline. In the October 1987 crash, we
review the argument that fundamental news moved the market down over 10 percent.
This significant market decline changed traders’ view of the viability of dynamic
trading strategies, which affected market operations, causing a downward revaluation
of stock prices and leading to a ‘‘crash’’ on October 19. In fall 2008, there was a
significant stock market drop related to fundamental factors of the seizing up of the
credit markets, major declines in the price of housing and resulting foreclosures,
declines in the value of CMOs, and the extent of bank leverage, bank failures, bailouts,
recession and overleveraging, but unlike 1987 there was little or no information
revealed about the trading strategies of stock market participants. Thus, we should
perhaps take little solace that within a year the market had recovered the value lost in
the crash of 1987 and the crash was not followed by a rece ssion. Things may be very
different now.
Notes
1. There are minor discrepancies in returns data reported for the S&P 500, depending on
source and data series used. For example, the center for research in security prices

(CRSP) value-weighted retur n including distributions series shows the returns from
14th-16th October as À2.79, À52 and À5.15 percent, respectively. By contrast, the
Return on the S&P 500 Index (NYSE/AMEX only) series on CRSP reports returns of
À2.95, À2.34 and À5.16 percent, respectively. In the paper our numbers correspond to
the latter series. Note that in either case the three-day cumulative return is À10.12
percent, which represents a minor difference to the À10.44 percent reported in Mitchell
and Netter (1989) based on the data available at that time.
2. See Lowenstein (2000) for a colorful account of this episode in the market, and its effect
on the hedge fund Long Term Capital Management (chapter 7 in particular).
What caused the
1987 stock
market crash
137
References
Cutler, D. Poterba, J. and Summers, L. (1989), ‘‘What moves stock prices?’’ Journal of Portfolio
Management, Vol. 15, pp. 144-47.
Dentzer, S., Thomas, R. Wang, P. and Friday, C. (1987), ‘‘Is the party almost over?’’ Newsweek,
26 October, pp. 50-4.
Gerety, M. and Harold Mulherin, J. (1991), ‘‘Patterns in intraday stoc k market volatility, past and
present’’, Financial Analysts Journal, September-October, pp. 71-9.
Grossman, S. (1988), ‘‘Analysis of the implications for stock and futures price volatility of
program trading and dynamic hedging strategies’’, Journal of Business, Vol. 61, pp. 275-98.
Haugen, R. Talmor, E. and Torous, W. (1991), ‘‘The effect of volatility changes on the level of stock
prices and subsequent expected returns’’, Journal of Finance, Vol. 46, pp. 985-1007.
Jacklin, C., Kleidon, A. and Pfleiderer, P. (1992), ‘‘Underestimation of portfolio insurance and the
crash of October 1987’’, Review of Financial Studies, Vol. 5, pp. 35-63.
Labaton, S. and Andrews, E.L. (2008), ‘‘In rescue to stabilize lending, US takes over mortgage
finance titans’’, New York Times, September 7, available at: www.nytimes.com/2008/09/08/
business/08fannie.html
Lem, G. (1987), ‘‘Changes in markets add to risk, NYSE boss warns’’, The Globe and Mail,

September 28.
Lowenstein, R. (2000), When Genius Failed: The Rise and Fall of Long-term Capital Management,
Random House Trade Paperbacks, New York, NY.
Miller, M. and Mitchell, M. (1999), ‘‘The stock market crash of 1987: what was all the fuss about?’’,
unpublished paper, University of Chicago GSB, Chicago, IL.
Mitchell, M. and Netter, J. (1989), ‘‘Triggering the 1987 stock market crash Àanti-takeover
provisions in the proposed house ways and means tax bill?’’, Journal of Financial
Economics, Vol. 24, pp. 37-68.
Mitchell, M., Pedersen, L. and Pulvino, T. (2007), ‘‘Slow moving capital’’, American Economic
Review, Vol. 97, pp. 215-20.
Presidential Task Force on Market Mechanisms (Brady Commission) (1988), Report,US
Government Printing Office, Washington, DC.
Roll, R. (1989), ‘‘The international crash of October 1987’’, in Kamphuis, R.W. Jr., Kormendi, R.C
and Watson, J.W.H. (Eds), Black Monday and the Future of Financial Markets,
Mid-America Institute for Public Policy Research, Irwin, Homewood, IL.
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About the authors
Ryan McKeon received his PhD from the University of Georgia in December of 2008. He will be
an Assistant Professor of Finance at the University of San Diego in the fall of 2009. His research
is in asset pricing.
Jeffry Netter is the C. Herman and Mary Virginia Terry Chair of Business Administration and
a Josiah Meigs Professor at the University of Georgia. He has a PhD from The Ohio State
University, J.D. from Emory University, and a BA from Northwestern University. He has taught
at the University of North Carolina and the University of Michigan. His research concentrates on
the interactions of law, economics, and finance in areas such as corporate control, corporate
governance, and politics and governance. He is the Managing Editor of the Journal of Corporate
Finance. Jeffry Netter is the corresponding author and can be contacted at:
To purchase reprints of this article please e-mail:
Or visit our web site for further details: www.emeraldinsight.com/reprints
RAF

8,2
138
Review of Accounting and Finance
Vol. 8 No. 2, 2009
pp. 138-154
# Emerald Group Publishing Limited
1475-7702
DOI 10.1108/14757700910959484
Has the 1987 crash changed the
psyche of the stock market?
The evidence from initial public offerings
James Ang
Department of Finance, College of Business, Florida State University,
Tallahassee, Florida, USA, and
Carol Boyer
Department of Finance, College of Business,
Long Island University-CW Post Campus, Brookville,
New York, USA
Abstract
Purpose – The purpose of this paper is to utilize the initial public offerings (IPO) market to research
the effect the stock market crash of 1987 had on the market psyche.
Design/methodology/approach – The paper compares the number of IPOs, as well as accounting
data during the years surrounding the 1987 crash to determine if there is a change in financial quality.
The underwriting fee structure, underpricing and short term price changes during one year prior to
and one year following the 1987 crash are examined, as well as the long term returns surrounding
the crash.
Findings – The stock market crash of 1987 did change the market psyche in the short to medium term.
Results show greater risk aversion in the post crash period, as evidenced by fewer IPOs from riskier
firms. Pricing is found to be more rational – less one day run-up, less upward adjustment from offering
range, and less likely to be overpriced in intermediate and longer terms.

Originality/value – The paper demonstrates the importance of market sentiment and may illuminate
the causes of market cycles.
Keywords Flotation, Stock markets, Stock returns, United States of America
Paper type Research paper
Introduction
On October 19, 1987 the Dow Jones Industrial Average declined 508.32 points (22.6
percent) which equates to a loss of $500 billion. This paper is an examination of
whether the 1987 stock market crash affected the psyche of the investing public. In
particular, we investigate whether the crash caused a structural change in the market
or a shorter-term behavioral change. The latter may include a drastic but short-term
shift in risk aversion by investors resulting in a flight to quality type of phenomenon.
Although flight to quality could be tested in principle with stocks that are traded, the
price run up prior to the crash may make the notion of quality difficult to define and
measure. A more direct approach is to examine the initial public offering (IPO) market,
where the test for flight to quality is simplified to whether only better quality (larger,
more profitable, longer history) unlisted firms offer IPO. We use characteristics of IPOs
to see if there are changes in the quality of IPO issuers due to the stock market cras h of
1987. This paper seeks to explain how the market crash affected the stock market with
respect to IPOs, both immediately and in the longer term. IPOs are interesting take on
the market psyche in that it involves both the response of supply from issuers and
demand by the investors. The event of the crash if resulted in a flight to quality could
manifest in the withdrawal from the market of certain potential issuers (lower quality)
as well as investor types (less risk averse/more optimistic).
The current issue and full text archive of this journal is available at
www.emeraldinsight.com/1475-7702.htm
The psyche of
the stock market
139
Data and theory
If the market crash caused the psyche of the market to change in the short term,

irrational behavior may be observed. In particular, having observed the occurrence of a
relatively rare event of over a 20 percent decline in a single day, the market would
assign much higher probability for a similar decline to occur in the near future, a result
of a small sample or representativeness bias. In addition, the exit of the most optimistic
investors would further reinforce a greater market discount for risks. Since the riskiest
stocks tend to decline more than the average, these effects would be felt mostly on high
risk stocks, and investors in these stocks were burned and would avoid them.
As a result of these factors, there should be a flight to quality in the following
months and years. This ‘‘flight to quality’’ hypothesis (Bernanke et al., 1996) states that
adverse shocks to the economy may be accelerated by worsening market conditions.
Essentially, the financial accelerator implies that borrowers with severe agency
problems have reduced access to credit during economic downturns. When applied to
IPOs, the ‘‘flight to quality’’ has the following predictions:
.
Only high quality firms issue IPOs. This means larger, more profitable, less
levered firms, less need for certification from third parties such as venture
capital firms, and from more established industries[1].
.
The pricing of IPOs could be lower than those issued prior to the crash due to the
withdrawal of the less risk averse investors; the discount is greater for riskier
shares.
.
The aggregate dollar and number of IPOs will decline, as lower quality issues are
being shut out of the market. However, the dollar value per IPO will rise
reflecting larger, less risky firms dominating the issue market.
.
Investment banks would have harder time marketing new IPOs, as reflected in
their greater selling expense.
.
The greater aversion to risk would also reduce the demand for IPOs from new

industries, a negative externality in reduced external funding for new ventures.
The null hypothesis is that the market was not affected by the crash, and there would
be no difference in the pre to post crash comparison. Underlying the hypothesis are the
assumptions that the market did not underestimate the probability of a crash earlier,
nor did it overestimate its probability afterward. They are simply regarded as what
they are, rare events. Investor sentiment is quite a relevant issue, as Siegel (1992) notes
that shifts in investor sentiment, perhaps induced by noise traders, were a factor in the
1987 stock decline. Our study examines investor sentiment and market psyche through
the IPO market. Similarly, Seyhut (1990) found evidence that suggests overreaction
was an important part of the1987 crash. In a related issue, Shiller (1989) surveyed
investor behavior around crashes and argued there were no changes in economic
fundamentals, and that investors merely trade based on price changes.
Results
Number of IPOs
The number of IPOs gives a sense of the IPO market momentum. Table I shows the
aggregate number of IPO’s in terms of issues and principal amount, both the sum and
average size of the given year. We can see that in the year before the crash (1986) that
the number of IPO s peaks at 708 for the eleven year period surrounding the 1987 cras h.
The year of 1987 had a smaller number of IPOs at 531, but this is still larger than the
RAF
8,2
140
preceding years of 1985 with 322 and 1984 with 343 IPOs. The relatively high number
of offerings in 1987 reflects the fact that there was a robust market for 9-10 months
prior to the crash. Clearly, the years of 1986 and 1987 had significantly larger quantity
of IPOs. After the 1987 crash, the quantity of IPOs did not reach the 1987 level until five
years later in 1992 when the number of the IPOs hit 56 1. In the three years following
the 1987 crash, the number of IPOs did not exceed 300 per year. Clearly, the 1987 crash
had an effect upon the quantity of IPO for several following years. Lowry (2002) finds
that investor sentiment is a determinant of aggregate IPO volume. The quantity of

IPOs had risen prior to the market crash, reflecting the sentiment driving the market to
new heights and overvaluation, which also drove the IPO market. The year 1987 is of
particular interest, as the table shows the momentum of IPOs were much in line with
the general stock market overheating at the time. Although we feel investor sentiment
influenced the IPO market following the 1987 crash, managerial timing to avoid the
depressed stock market may also be a plausible explanation.
In terms of the principal amount, Table I shows both the sum and average principal
amount for each of the eleven years surrounding the 1987 crash. The principal amount
numbers are not inflation adjusted. The years 1986 and 1987 were peak years with the
sum in 1986 at $22 billion and 1987 at $24 billion. The numbers in 1987 are the sum of
two regimes – the uptrend in principal continued up to the October crash, and declines
afterward. The decline in the number of IPOs immediately after the crash may be a
result of investment bankers concern over their reputation. Dunbar (2000) studied how
the withdrawal of IPO from October 1987 to December 1987 affected market share of
investment banks later, their ability to complete IPOs did impress potential issuers, so
this factor may be more important than cost of issuance. In the year 1988, although we
see a similar aggregate level at $22 billion, the issue market was dominated by large
issues, with average issue size almost twice that of previous years. This supports the
tendency of investors’ flight to quality immediately after the crash. But in the years
following a decline to $13 billion in 1989 and $11 billion in 1990. However, the market
recuperates by 1991 as the sum resumes to the 1987 level of $24 million. The experience
of the crash appears to have left the market with a sour taste, or bad memory for at
Table I.
Aggregate IPOs in
number of issues and
the sum and average
principal amount
Year
Principal amount
Number of IPOs

Sum of all
markets ($ mil)
Average of
all mkts ($ mil)
1982 118 1,215.8 10.3
1983 673 12,071.7 17.9
1984 343 3,154.8 9.2
1985 322 6,332.8 19.7
1986 708 22,008.7 31.1
1987 531 24,055.2 45.3
1988 268 22,411.5 83.6
1989 240 13,482.2 56.2
1990 207 11,076.2 53.5
1991 387 24,908.8 64.4
1992 561 64,309.7 115.5
1 January 1987 to 19 October 1987 508 22,690.0 44.7
19 October 1987 to 31 December 1987 22 1,300.2 59.1
Note: Data are from Thomson Financial Securities Data Corpor ation