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Crash Of 1987 Essay

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The Crash of 1987 is one that poses several questions. Academics and analysts alike have various theories behind the reasons of the crash. While many believe that the causes were mainly fundamental, some argue for the behavioral aspects of the Crash. Overreaction, herd behavior, risk aversion and representativeness heuristic are some of the behavioral theories that analysts have come up with along with empirical evidence. Due to the limited scope of the paper, we will attempt to highlight and analyze the behavioral aspects of the Crash strictly from a theoretical point of view. Representativeness heuristic is a behavioral tendency of people to generalize events and categorize them according to a common or well-known class. The problem with this is that such heuristics fail to take important underlying probabilities into account …show more content…

Another possible explanation behind the Crash of 1987 was the problem of representativeness heuristic. Frankel (2008), in his paper, cites Shiller's (1998) explanation that reliance on historical data is an example of representativeness heuristic. In Frankel's (2008) paper, two types of investors are considered: naive and rational investors. Rational investors closely look for signals in the market and act accordingly (lower or increase the price they bid for the stocks). On the other hand, naive investors make rash judgments based on patterns (a problem of overconfidence) and since most investors tend to be risk averse, they sell their stocks assuming prices will further fall eventually leading to a crash in the market. The paper notes that many investors independently observed close patterns like this in both the 1929 and 1987 crashes . In fact, we learn, that on the morning of Black Monday, the Wall Street Jorunal

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