One week after stock markets dropped 10% in half an hour, regulators still confess bewilderment yet equally resolve never to let it happen again. No one at the SEC or CFTC or any of the exchanges has been able to identify a particular cause of the flash crash. They do say the precipitous decline was magnified by how some trading platforms, like the old-fashioned New York Stock Exchange, halted trading when the downward spiral began while electronic trading platforms did not.
A consensus appears to believe that this worsened the spiral because trades could still be made elsewhere but with fewer participants, in a thinner market. Adherents think the cure is obvious: such trading breaks should be adopted across all trading platforms so if there is ever any significant decline in price, all trading would halt. I respectfully dissent.
This is a replay of the 1987 stock market crash: no one could figure out why it happened so everyone decided such circuit breakers were the thing to do about it. The consensus is likely to be just as wrong today as it was wrong then, based on an alternative view, which I laid out in my 1994 GW Law Review article, From Random Walks to Chaotic Crashes: The Linear Genealogy of the Efficient Capital Market Hypothesis. Those seeking an explanation for the 1987 crash and last week’s flash crash presuppose things about stock markets and pricing that may simply be false. Read More