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Paper on History of Market Crises : Facts, Figures and Impact on the Economy

   

Added on  2020-07-23

54 Pages19361 Words69 Views
History of Market Crises:Facts, Figures and Impact on the Economy

ABSTRACTStock Markets' behaviour usually functions as a leading indicator of economic andfinancial crisis. The paper will define market crisis, make a literature review and discussvarious market crises that have been occur from 1987 to date and empirically examine theconsequences on major indexes, compare the results and focus on the effects on realeconomy. The study examined the six major stock indexes of the major world economiesexcept China, for the past 24 years. During my research period, (1987 - 2011) stock marketshad experienced seven major crises and each one was lighter than the previous with theexception of the subprime crash of 2008 that caused an analog to 1907 sell panic.The research examines the black Monday 1987 crisis which was considered thebiggest one day crash in history, 1990 crisis which caused mainly by oil prices increase, 1998crisis when Russian economy defaulted , 2000 dotcom crisis when tech stocks reachedbubble levels, 9/11 terrorist attacks crisis, and 2008 credit crunch.According to the results, all major indexes need the same time to reach bottom,recover to their pre-crash levels with few exceptions, and remain at the bottom similar periodof time. However, European markets are better correlate and especially the German and theFrench Index in terms of time, recovery, duration and performance. US and European Indexeshave many in common but there are differences as well, while Nikkei deviates from all otherindexes.2

TABLE OF CONTENTSCHAPTER: 1 INTRODUCTION..................................................................................51.1 Background of the study......................................................................................51.2 Research aims and objectives...............................................................................61.3 Rationale..............................................................................................................61.4 Potential contribution...........................................................................................61.5 Disposition...........................................................................................................7CHAPTER: 2 LITERATURE REVIEW.......................................................................82.1 Introduction..........................................................................................................82.2 Market decline, market panic and stock market crash.........................................82.3 Bull or bear market characteristics and relationship with t panic and crash........92.3 Recession Vs depression....................................................................................102.4 Use of stock market for crisis prediction...........................................................11CHAPTER: 3: METHODOLOGY..............................................................................163.1 Introduction........................................................................................................163.2 Research paradigm.............................................................................................163.3 Research approach.............................................................................................163.4 Research type.....................................................................................................173.4 Data collection...................................................................................................173.5 Data analysis......................................................................................................183.6 Ethical aspects....................................................................................................18.CHAPTER: 4 DATA FINDINGS AND ANALYSIS................................................18CHAPTER: 4 DATA FINDINGS AND ANALYSIS.................................................194.1 Crises..................................................................................................................194.1.1 The 1987 Black Monday crisis.......................................................................194.1.1.1 Facts and Figures.........................................................................................194.1.1.2 Causes..........................................................................................................19Derivative Securities............................................................................................19Program Trading..................................................................................................20Illiquidity..............................................................................................................20US trade budget deficit.........................................................................................20Overvaluation.......................................................................................................204.1.2 The 1990 crisis................................................................................................214.1.2.1 Facts and Figures..........................................................................................214.1.2.2 Causes..........................................................................................................21Oil Prices..............................................................................................................21Demographics and the Deceiving Population......................................................21The Tax Reform Act (1986).................................................................................22High Leverages....................................................................................................224.1.3.The Russian Crisis of 1998.............................................................................224.1.3.1 Facts and Figures..........................................................................................224.1.3.2 Causes..........................................................................................................23Decline in Exports................................................................................................23Speculative Attack...............................................................................................23Currency Crisis.....................................................................................................23Budget Deficits.....................................................................................................23Banking Crisis......................................................................................................244.1.4 The dotcom crisis of 2000...............................................................................243

4.1.4.1 Facts and Figures..........................................................................................244.1.4.2 Causes..........................................................................................................24Corporate Corruption...........................................................................................24Overvaluation of Stocks.......................................................................................25Microsoft Monopoly............................................................................................254.1.5The 9/11th Crisis...............................................................................................254.1.5.1 Facts and Figures..........................................................................................254.1.6. The Great Recession......................................................................................264.1.6.1 Facts and Figures..........................................................................................264.1.6.2 Causes..........................................................................................................27Easy Credit Conditions........................................................................................27Growth of Housing Bubble..................................................................................27Fraudulent Underwriting Practices......................................................................27Increased Debt Burden.........................................................................................27CHAPTER: 5: CONCLUSION AND RECOMMENDATION..................................40Conclusion................................................................................................................40Recommendations to Prevent Stock Market Crisis..................................................41SUMMARY OF LEARNING REFLECTIONS..........................................................43REFERENCES.............................................................................................................44APPENDIXES.............................................................................................................494

CHAPTER: 1 INTRODUCTION1.1 Background of the study During the past thirty years world came across severe crises that had and still havemultiple social and economic effects. Crisis is a situation when economy experience suddendownturn caused by financial crisis. It drop gross domestic product, liquidity crunch, fallingstock prices and have a drastic impact on the financial, economic, social and political aspectHowever, on the other side, it offer opportunities to everyone that can discriminate the newfinancial and socio-economic status after every crisis. They eliminate weak and less adaptablecompanies, leaving free space for the future market leaders in all sectors of the economy.Although social sciences, along with finance and economics have shown a considerableprogress during the last 100 years, however, collapse of stock prices has resultant economicdisruption. It found as a key factor behind great depression and recession. Recently, globalinstitutions like IMF and World Bank (2014) examine past financial crises to respond thecrises by identifying their key reasons and make better decisions to put closer supervisionmechanism. Stock market works as an early warning indicator of crisis, in which,policymakers can examine current market trends with the historical occurrence and assesseconomic stability. World Bank (2014) focuses on structural problems in the financial systemthat deviates human behavior from making rational decisions. Although there were number of studies, which examine the impact of crisis on theeconomic output, still, none of the research pays specific attention on capital market crashbecause of crisis. Thus, the key aim of the research paper is to examine all major marketcrises from 1987 up to the late 2008 credit crisis that was a major one and almost all,academics, politicians, economists and investors, agree that it was the worst since the crash of1929 that caused the Great Depression. The ‘Black Monday’ of 1987, was followed by therecession of 1990, the Asian crisis which started on 1997 and disrupted the economy of Asiangiants. The Asian recession was followed by currency crisis in Russia in 1998 in whichRussian domestic problems were held responsible for the crash. After the Russian crisis, thedot-com bubble distorted the economy Worldwide which was due to the extremeovervaluation of tech stocks in 2000. Another unexpected market crisis occurred due toterrorist attacks of 9/11 and the impact was so severe that the stock market remained closedfor four days globally. Lastly, stock market crisis occurred in 2007 – 2008, also known ascredit crunch which triggered after a couple of years the eurozone crises. These variousincidents affected among others, the global economy, changed the way risk was considered,and altered social status and market profile in many sectors globally. The thesis will analyze indexes behaviour of the major capital markets before andafter the period of crisis and its impact on the economy. The study particularly focuses on5

analyzing 6 major stock markets including Dow Jones and S&P500 of New York StockExchange, FTSE100, DAX30, and CAC40 of European Exchanges and Nikkei 225 ofJapanese Stock Exchange. The research will examine that how stock prices change duringvarious crises through key facts and figures. Moreover, it will find out that how stock marketpricing pattern and volatility can be use by economists as a tool of predicting future crisis.Thorough examination of causes of recession and its impact on the economy will enableresearcher to present the most appropriate solution to respond it in the best way. 1.2 Research aims and objectives The dissertation aims at critically examining the causes and impact of crisis oneconomy, more importantly, six major capital markets of the world including DowJones and S&P500 of New York Stock Exchange, FTSE100, DAX30, and CAC40 ofEuropean Exchanges and Nikkei 225 of Japanese Stock Exchange.Research objectives: To critically examine the key reasons of major crisis Black Monday crisis, 1990crisis, Russian Crisis, dotcom, 9/11 crisis and great recession To examine the performance of selected major capital market before, during and post-crisis period To analyze the impact of crisis on the economic results To recommend the best strategies to policymakers to respond crisis 1.3 RationalePreviously, many researchers have tried to quantify crises in macroeconomic terms orexplain their pattern repetition. Fidrmuc and Korhonen (2010) investigated the impact ofglobal financial crisis on the business cycles and Reinhart and Rogoff (2009) researched theeconomic results after crisis. However, both the studies did not specifically focus theirattention on collapse of major stock market. Thus, it is the main reason, which motivateresearcher to investigate how financial crisis damaged major capital markets of the world.Moreover, no research has been undertaking that present key information about how stockmarket volatility can be use as a predictive tool for crisis measurement. Thus, the study willcover such gap by focusing key attention on the stock market. 1.4 Potential contribution Critical evaluation of the underlying causes of crisis and its impact on the economywill assist policy makers, monetary and federal authorities to respond such situation.Moreover, the study findings and results can be used by academics, fund managers andanalysts in order to better interpret markets’ behavior on crises while, economists and policymakers can use it to predict a market crisis, its duration and depth or even act proactively.6

1.5 Disposition Chapter: 1: Introduction: This section of the study provides background details,aims and objectives, rationale and potential significance of the study. With the help of this,reader can generate an idea about the scope and key aspects covered by the study to achievethe defined goals. Chapter 2: Literature review: This section presents critical assessment of historicalacademician’s researches and investigations about the key aspects such as stock market,market crisis, recession, depression. This chapter gains crucial importance such as stockmarket, market crisis, recession, depression and evaluate different authors point of view aboutthe causes and impact of market crisis on economy. Chapter 3: Methodology: The section outlines the research methods, tools andconcepts including data collection and data analysis method that researcher used to completethe investigation.Chapter: 4: Data analysis: It is the most important chapter that present key facts,figures and trend of all the selected major stock markets before, during and post-crisis. Itsdetailed evaluation will enable researcher examining the trend and assess that how stockmarket behave at different point of time and alert policymakers against possible market crisis.Chapter: 5: Conclusion and Recommendation: The thesis ends with conclusionsummarizing the key findings of the study undertaken. Based on it, policymakers, economistand federal authorities will be recommending for the most suitable strategy to protect theeconomy against crisis. 7

CHAPTER: 2 LITERATURE REVIEW2.1 Introduction Literature review section presents thorough and in-depth analysis of thehistorical research papers and academic’s researches that help to build criticalarguments. This section focuses on key aspects including market crisis, market panics,market crashes, recession and the key reasons behind crisis. 2.2 Market decline, market panic and stock market crash A market decline is a logical consequence of a market uptrend in technical terms or anegative fundamental issue. Prices drop or decline after achieving the saturation point ismarket declining. However, stock market crash is not similar to this, even market crash andmarket panic are not describing the same market event. Crashes are often a logicalconsequence of a speculative market bubble that could bring fundamentals to an irrationalextreme level as measured by P/E and P/BV ratios, market capitalization or dividend yields.Stock market crash is a rapid decline in the prices of shares that traded on recognized stockexchange due to panic selling. It lost investors confidence on the market due to unexpectedevents such as prolonged inflation, political uncertainty, hysteric speculation and others.Stock market crashes and panics are a result of human behavior. Actually, a result ofthe reaction of the crowd of investors where fear brings selling which brings more sellingpressure and the result is a crash or a panic. Both they have to do mainly with humanpsychology and less with market fundamentals. Barben and Odean (2000),reported thatoverconfidence among investors resultant excessive trading level at poor performance. Out of66,465 households with large discounting broking during 1991-1996, investors who tradeexcessively earned an annual return @ 11.4% only against the market return of 17.9%.However, average household get an annual return @ 16.4%. The results show thatoverconfidence is the main reason behind poor performance, which reported that excessivetrading is hazardous to wealth. Besides this, Kahenman reported that availability biasness affects investors informing crash beliefs. The study demonstrates that in order to form prediction, people usessome possible arbitrary value and make necessary adjustments, which is often insufficient.8

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