Black Monday 1987
On 19 October 1987 the Dow fell 22.6% in a single day. Learn what caused Black Monday, the role of portfolio insurance, the Fed's response and its lasting legacy.
On Monday 19 October 1987, the Dow Jones Industrial Average fell 508 points, or 22.6%, the largest one day percentage decline in its history. Markets around the world crashed too. Remarkably, there was no single piece of news that explained the scale of the fall. Black Monday showed how market structure, automated strategies and herd behaviour can create a crash, and it led directly to circuit breakers and to the modern idea that central banks will act to stabilise markets in a crisis.
What happened#
| Date | Event |
|---|---|
| August 1987 | The Dow peaks after rising strongly during the year |
| 14 to 16 October | Stocks fall sharply on trade deficit data, rising interest rates and tax proposals affecting takeovers |
| 19 October (Black Monday) | The Dow falls 22.6%; the S&P 500 falls about 20.5% |
| 20 October | The Federal Reserve announces it will provide liquidity; markets stabilise after a volatile session |
| Following months | Markets recover gradually; the Dow regains its pre crash high in 1989 |
Markets fell across the world, with large declines in Hong Kong, Australia, the UK and elsewhere, some of which exceeded the US fall.
Causes#
| Factor | Role |
|---|---|
| Overvaluation | Stocks had risen substantially in 1987 while bond yields climbed |
| Rising interest rates | Higher yields made bonds more attractive relative to stocks. See Interest Rates |
| Portfolio insurance | Strategies sold index futures as prices fell, adding to selling pressure |
| Market structure | Futures and stock markets became disconnected; specialists and order systems were overwhelmed |
| Herd behaviour | Fear and the expectation of further falls fed selling |
Portfolio insurance#
Portfolio insurance was a dynamic hedging strategy that aimed to protect a portfolio by selling stock index futures as the market fell and buying them back as it rose, replicating a put option. In a fall, many insurers sold at once. Their selling pushed futures down, which pushed stocks down through arbitrage, triggering more insurance selling, a feedback loop. The Brady Commission report in 1988 identified portfolio insurance and the disconnect between markets as key contributors. See Delta Hedging and Protective Put.
The response#
- The Federal Reserve, under new chair Alan Greenspan, issued a brief statement on 20 October affirming its readiness to serve as a source of liquidity, and encouraged banks to keep lending to securities firms.
- Circuit breakers were introduced in US markets to pause trading during extreme declines. See Trading Halts and Circuit Breakers.
- Improvements to order handling systems and coordination between futures and stock markets followed.
Legacy#
| Legacy | Explanation |
|---|---|
| Volatility skew | After 1987, out of the money index put options became persistently more expensive than calls. See Volatility Smile and Skew |
| Fat tail awareness | Risk managers recognised extreme moves happen more often than models assumed |
| Central bank backstop | Markets came to expect Fed support in crises, sometimes called the "Greenspan put" |
| Circuit breakers | Market wide trading halts remain in place today |
Lessons#
- Crashes can happen without clear news when positioning and structure are fragile.
- Strategies that sell into falls can amplify crashes when widely used. See Factor Timing, Crowding and Crashes.
- Stress test for extreme moves, not just normal volatility. See Stress Testing and Scenario Analysis.
- Stops can fill far from their levels in a crash. See Slippage.
- Long term investors who held recovered, while leveraged traders forced to sell locked in losses.
Sources#
- Federal Reserve History, "Stock Market Crash of 1987": https://www.federalreservehistory.org/essays/stock-market-crash-of-1987
Frequently asked questions#
What happened on Black Monday 1987?#
On 19 October 1987, the Dow Jones fell 22.6% in one day, the largest one day percentage drop in its history, with crashes in markets worldwide.
What caused Black Monday?#
Overvaluation, rising interest rates, portfolio insurance selling, market structure problems and panic combined, without a single clear trigger.
What changed after the 1987 crash?#
Circuit breakers were introduced, market systems were improved and the Federal Reserve's role as a crisis backstop became firmly established.
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Mentioned in
- Volatility Smile and SkewVolatility
- Normal DistributionMath and Statistics