Market efficiency before and after the crash

<p>The worldwide stock market crashes of October 1987 were a cause of major public concern at the time, because of the natural fear that they would be followed by economic collapse, as was the case in 1929. The fact that this pattern shows no sign of being repeated is an enormous relief for all of us. However, it leaves the economics profession in the invidious position of being able to explain neither what causes stock market fluctuations nor their relevance to the real economy. The feeling is rather like that of a doctor confronting a patient showing every sign of excellent health two years after the first, unexplained appearance of symptoms of terminal disease. In particular, it is hard to reconcile the crash with the prevailing orthodoxy of market efficiency and rational expectations (which are explained in Sections I and II). The paradigm was already being questioned by researchers before 1987 (Section III). It is argued here (in Section IV) that the crash effectively left no more room for controversy.</p>