Price volatility, international market links, and their implications for regulatory policies

Abstract

Disastrous events sometimes engender redeeming social benefits. The international crash of equity markets in mid-October 1987 is a case in point, for it has provoked many scientific papers, both theoretical and empirical, on market volatility, international market links, and market structure, papers that may have never been written without the crash as a catalyst. The purpose of the present article is to provide an assessment of some of the most significant empirical studies and to summarize their implications about possible regulatory reform of the equity and futures markets. In addition, I will present some new evidence about volatility and its relation to existing market regulations across countries. Specifically excluded from my survey of empirical papers will be reports provided by various "commissions." Some of these reports contain fine empirical work, but they are not really scientific studies in the sense of having been subjected to a thorough review by peers before publication. Kamphuis, Kormendi, and Watson (1989) provide excerpts that include the most important empirical results from six different commission reports. But even without such commission reports, there are plenty of good papers to examine, some of which have surprising new conclusions. Their technical sophistication is often quite advanced for the general reader, so one of my goals is to summarize their contributions in nontechnical language. The October 1987 Crash posed three important scientific questions: 1. What were its causes? 2. Why and how did it propagate internationally? 3. Was it related to particular institutional practices, market arrangements, or regulatory policies? The subsequent three sections of the article are devoted respectively to evidence about these three questions.