The history of stock market crashes

Academic Paper, 2018

10 Pages, Grade: A


Table of Contents

1. Introduction

2. The first big crash

3. The Great Depression

4. Modern Crashes

5. The Crisis of 2007/2008

6. Conclusion

1. Introduction

A stock market crash can be defined as an extreme price collapse on the stock market. Usually this process takes a few days to a few weeks. During this period mostly panic sales, which generate a large excess supply and thus lead to drastically falling prices dominate the scene. Stock market crashes usually occur at the end of a speculative bubble. However, they can happen unexpectedly, following negative events as for example the bankruptcy of the “Lehman Brothers” in 2008, or in extreme cases also completely without any indicating beforehand news. The reaction that starts a crash commonly are some market participants that sell their securities, causing prices to start to fall. This drives further participants also to sales and the courses fall further. There is no absolutely clear definition of the term stock market crash. In contrast to the bear market, prices fall faster and more suddenly, an expression of panic sales. Throughout this paper I would like to outline the largest stock market crashes in modern history, and furthermore explain the underlying reasons behind.

1. The first big crash

The first severe crash of a stock exchange took place in 1637 in the Netherlands. At that time, however, it was not stocks or bonds that were traded but tulip bulbs. In the years before, half of Holland had begun to speculate with tulips, which at the time were considered exotic in Europe. At that time there were also futures on the flowers. At the height of speculation, a tulip onion was paid at the equivalent of 87,000 Euros. When the buyers were finally missing, the market collapsed like a house of cards. Nevertheless, the Dutch have kept their love for the tulips, up to today the country is one of the most important tulip producers (Moore, A., Artz, J., & Ehlen, C. R. (2017)).

2. The Great Depression

The first, and one of the most famous, crashes in the 20th century, happened in 1929. The US economy boomed during the time of the so called “golden twenties”, stock prices rose and rose. The Shiller P / E of the S & P 500 Index, a 10-year average of the price-earnings ratio named after Nobel laureate Robert Shiller, peaked at 32.5. The long-term average is only 16.8. Shares were then almost as expensive as today (current Shiller P / E: 31.98). Only for the dotcom bubble, the ratio was even higher; at the end of 1999, it equaled, for the 500 largest US stocks on average 44.2. In 1929, many investors dreamed that they would be able to live permanently from the price gains and not have to work any longer. For this they also took out loans and bought shares on pump. After the 1929 crash many investors were ruined, many even committed suicide. Incidentally, the crash in the USA was already interpreted in the summer by falling prices in Europe. Sales of durable consumer goods such as furniture also stagnated, but the US economy had greatly expanded production. Today, the crash is considered the trigger of the so called Great Depression.

After 1929 people were a lot more careful and partly learned their lesson. It took quite a long time until the next big crash occurred in 1987, the first stock market crash after the Second World War. The Dow Jones fell 22.6 percent, or 508 points, in one day; this was the largest percentage decline within a day in its history. The fall quickly spread to all major international stock exchanges. By the end of October, stock prices fell 41.8 percent in Australia, 22.5 percent in Canada, 45.8 percent in Hong Kong and 26.4 percent in the UK. The crash was preceded by no drastic events. To date, it is disputed which factors led to this stock market crash. The Dow Jones had almost doubled since 1985; In August 1987, however, there were increasing signs of an end to the bull market. Thus, the cabinet of president Ronald Reagan failed to get the inflation and the excessive trade deficit, equaling 152.1 billion US dollar, in order. Uncertainty increased as the US Federal Reserve raised interest rates on short-term loans for the first time in three years. The Dow Jones had lost since its high in August of October 13, 1987 in several jumps about 475 points in value. Added to this was growing uncertainty in the currency markets and a loss of confidence in the US dollar. The devaluation of the dollar in the wake of the “Plaza Agreement “seemed to have stopped first with the “Louvre Agreement” in February 1987, but at the end of September there were rumors in the media about a dispute within the G7 countries. On Friday before the stock market crash, the dollar fell abruptly to 1.77 DM. The uncertainty was compounded by an article in the following Sunday edition of the New York Times, in which US Treasury Secretary James Baker indirectly opposed further support for the dollar, threatening to let the dollar fall further if Germany did do not show willingness to compromise in the interest rate dispute (Reynolds, P. I. (2012)).

Furthermore, the extent of the stock market crash was largely due to the increasing computerization of exchange trading such as computer exchange and automated trading. Since the early 1980s, traders had increasingly used computers for their portfolio strategies, and typically the big banks had very similar dynamic hedging systems. Extensive automation meant that within a short period of time after initial selling pressure had arisen, the hedging strategies either short-sell stocks or short-futures and put options on the futures exchanges. The amount of simultaneous incoming orders generated further selling pressure and there was a cascade effect (Holley, D., & Trescott, P. B. (2013)).

3. Modern Crashes

On October 20, 1987, the Dow Jones initially fell further to 1739 points, the Nikkei 225 in Japan slipped 14.9 percent or 3383 points to 21910 points. On many stock exchanges, trading was suspended for a short time; partly because the computer technology of the time was not up to the high order volume. This gave the US central bank time to pump liquidity into the market and cushion the crash. In addition, companies started buying back their own shares, either to support the price and or to use the low prices as a buying opportunity. At the end of the week, the Dow Jones was back at 1951 points. 15 months after the "Black Monday" the Dow Jones had again reached its pre-crash level with 2247 points.

The next big downslide followed in March 2000. However, the so called dot-com bubble was more of a correction than an actual instant crash, that lasted for a good two years. The term dot-com bubble is a term coined by the media for a burst in March 2000 of a speculation bubble, which in particular the so-called dot-com companies of the “new economy” concerned and led, especially in industrialized countries to loss of assets for retail investors. The term dotcom refers to the Internet domain extension ".com" Other names were Internet bubble or New Economy Bubble.

The dotcom bubble was a worldwide phenomenon. The largest market for technology companies was the US NASDAQ. In Germany, for example, “Deutsche Börse” set up the “New Market” as its own market segment, where allegedly trend-setting and fast-growing companies, which were regarded as "technology companies", should be listed. Compared to the US, the German dot-com bubble was heavily influenced by criminally acting entrepreneurs. The cause of the boom was the high earnings expectations as well as the speculation on rising stock prices, which were sparked by new technological developments. The establishment of the Internet and the mobile phone as well as the development of handheld computers led to a departure in the field of digital technology. Therefore, starting in 1995, a large number of new start-ups of companies and due to the great interest of investors increasingly went public. Many investors took the hope that the companies operating in these markets would be "forward-looking companies" and wanted to participate in supposed future profits through a share purchase or to share in the resale of shares through rising prices (Schaede, U. (1991)).


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The history of stock market crashes
Post University  (Malcolm Baldrige School of Business)
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Peter Rössel (Author), 2018, The history of stock market crashes, Munich, GRIN Verlag,


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