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October's Market Demons: The '87 Stock Market Crash and Likelihood of a Recurrence
Nov 1, 1998
In this article, we presented some perspectives on the crash of October 1987. We found that the likelihood of a market crash increases dramatically if the unconditional distribution of stock returns is fat-tailed with very large (possibly infinite) higher-order moments. Our study of GARCH forecasts showed that, with the exception of the crash itself, these forecasts were at least partially successful in capturing sharp movements around the period of the crash. We found that option-implied volatility has increased dramatically over the past one year, suggesting that the market expects higher volatility in the weeks/months ahead. Finally, we offered some thoughts on the impact of the crash on backtesting and performance evaluation. We showed via a simulation study that including the month of the crash does not have a significant effect on the ex-post information ratios of a market timer.