Stock prices are, by necessity, single numbers at any point in time, but reflect the estimate of probabilistic futures. If I am holding a sealed box that has an equal probability of holding $10 or $30, the selling price of the box will be $20 right now, and after being opened there will be either an immediate 50% drop or an immediate 50% rise in price. The pricing was rational throughout, even though a radical change in price occurred after opening the box.
In 1987, there is some evidence that major moves were associated with the surprise introduction into a Congressional committee of legislation to make mergers much less favorable from a tax point of view, and activity the week of the crash could well be correlated with the best guess of the outcome. The fact that the legislation was withdrawn after (and perhaps as a result of) the crash could explain the absence of follow up and the recovery of the market.
Wednesday, April 29, 2009
Rational doesn't mean omniscient
Less Antman comments: