Program Trading and Price Movement: Evidence from the October 1987 Market Crash

N The October 19, 1987 market crash fueled the debate as to the effect of program trading on market stability. The unprecedented price movement also provided a natural experiment to help resolve the debate and prompted the collection of program-trading data that had not previously been available. This study uses the new data to examine the relationship between program trading and price movements. Following the market crash, several institutions undertook studies that included analyses of program trading, but there is still no consensus as to the role of program trading in the crash. The Brady Report [2, p. 15] concludes that a "limited number of investors" using portfolio insurance "played a dominant role" during the crash. The SEC's Division of Market Regul tion report (hereafter referred to as the Division Report) asserts " 'program trading' [was] a significant factor in accelerating and exacerbating the declines" [22, p. xiii]. In contrast, the Commodity Futures Trading Commission report [4, p. 137] states that a "detailed examination of the trading data ... does not provide empirical support for the theory that hedging in the futures market and index arbitrage activities interacted to cause a technical downward price spiral of stock prices." Similarly, the Chicago Mercantile Exchange report [18, p. 56] concludes that (i) "index arbitrage does not appear to have played a major role in the crash," and (ii) although "portfolio insurance did conThis study has benefited from the comments of Brandon Becker, Ken Lehn, Mark Mitchell, Harold Mulherin, Rob Neal, Jeffry Netter, Stephen Newmark, Charles Trzcinka, Darrell Williams, and an anonymous referee. The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publication or statement of any of its employees. The views expressed here are those of the author and do not necessarily reflect the views of the Commission or the author's colleagues on the Staff of the Commission.