Black Monday in New York,Blue Tuesday in Tokyo: The October 1987 Crash in Japan

Brady Nicholas F. , (Chairman), Report of the Presidental Task Force on Market Mechanisms (Washington, D.C.: U.S. Government Printing Office, 1988; SEC (U.S. Securities and Exchange Commission), The October 1987 Market Break, A Report by the Division of Market Regulation, 1987; CFTC (Commodity Futures Trading Commission), Final Report on Stock Index Futures and Cash Market Activity During October 1987, 1987; CME (Chicago Mercantile Exchange), Final Report of the Committee of Inquiry, Appointed by the Chicago Mercantile Exchange to Examine the Events Surrounding October 19, 1987, 1987.

Cabot Anne , “Unravelling the Global Collapse or Looking to the Futures,” Sanyo Securities Marketing, October 26, 1987; Cabot Anne , “A Post-Crash Re-Examination of Asian Futures Markets: Will Japan Provide a More Viable Structure?” Presentation at the Berkeley Program in Finance in Asia Conference, Singapore, June 1988.

Roll Richard , “The International Crash of October 1987,” in Kamphuis Robert W. , eds., Black Monday and the Future of Fiancial Markets (Homewood, IL: Irwin, 1989).

Interviews at the Ministry of Finance and the Bank of Japan, November 1987 through February 1988.

Since most stocks have a face value of ¥50, this translates into 1000 shares; however, there are stocks with a face value of 20, 500, and 50,000 Yen also, which trade in units of 2500, 100, and 1 shares, respectively.

Computer-Assisted Order Routing System; the system does not change the trading rules.

For a discussion of the details of the trading system and “market making” in Japan, see Lindsey Richard R. Schaede Ulrike , “Specialist versus Saitori: Market Making in New York and Tokyo,” Finance Working Paper, IBER, University of California, Berkeley, 1990.

There is no size priority; smaller orders will be filled first if they come in first.

Minimum price fluctuations are different from the tick which is oriented at the current price of the stock: Up to 1000 Yen = 1 Yen, up to 10000 Yen = 10 Yen, up to 100,000 Yen = 1000 Yen, and more than 100,000 Yen = 10,000 Yen.

Haraf William S. , “Lessons of the Stock Market Crash: What We Have Learned about Securities Markets and Their Regulations,” The AEI Economist (May 1988), pp. 1–7.

The sharp decline of the TSE and the gyrations in summer 1990 are also attributable to a large part to the weakening of the dollar against the Yen and the volatility of exchange rates. This suggests that in general the TSE is much more sensitive to exchange rate fluctuations than the NYSE.

Kyle Albert S. , “Improving the Performance of the Stock Market,” California Management Review, 30/4 (Summer 1988): 90–114.

Those referred to as the “Big 4” are Nomura, Daiwa, Nikko, and Yamaichi Securities; their share of total trading volume at the TSE was more than 50% in the 1980s.

The fiscal year in Japan runs from April 1 through March 31.

The record index advance of October 21, 1987, held until October 2, 1990, when the index climbed 13.2% on one day in reaction to a change in margin requirements by the MOF. The ministry changed margin requirements in order to give the market a break from the sharp downturn in 1990, and it can be assumed that these measures were adopted in 1990 because they had worked so well in 1987.

The steady upward trend in 1988, however, did not come along without MOF support. When the market threatened to falter again in January 1988, the Ministry released new rules for so-called Tokkin funds. Institutions do not have to declare capital gains on Tokkin funds, but they may take deductions for capital losses. Life insurance companies can disguise their capital gains (out of which they are not allowed to pay dividends) as income (on which they can pay dividends). Due to these special features Tokkin were one of the major instruments in the “Zaiteku” Boom (from Zai, finance, and teku, short for technique) between 1985 and 1989. Since MOF was not delighted by this boom, it had announced a major change in accounting rules for Tokkin funds. When the stock market weakened in January 1988, the Ministry withdrew the announcement, so the proposed reform did not affect the institutions' balances for fiscal year 1987/88. In 1990, the rules have been changed gradually (after announcement far in advance). This might be one of the contributing factors to the long and uninterrupted downturn of the Japanese stock market in 1990, because institutional investor retreat from the market and/or are more cautious in their investment behavior.

Treynor Jack , “What Does It Takes to Win the Trading Game?” Financial Analysts Journal (January/February 1981), pp. 55–60.

Kyle , op. cit.

Ibid.

The law was changed in 1988, when stock index futures where included in “securities” traded at the stock exchange. In September 1988, stock index futures were introduced on the TOPIX in Tokyo, and on the Nikkei 225 Average Index in Osaka. For details, see Schaede Ulrike , Der neue japanische Kapitalmarkt—Finanzfutures in Japan (Wiesbaden: Gabler, 1990). With a similar legal background, the Toronto Stock Exchange introduced stock futures on a basket of 10 stocks (100 shares each) in 1983. In the first year, only 5748 contracts were traded, without a single physical delivery. After revision of the law, stock futures were abolished and stock index futures on the Toronto Stock Exchange 300 Composite Index were introduced in 1984.

Forty-nine of the basket stocks trade in round lots of 1000 shares (face value: ¥50), while one, Kansai Electric Power (face value: ¥500) trades in units of 100 shares. However, to simplify quotation, the price of this stock is converted to a round lot of 1000 shares.

The OSF 50 contract lost all its volume, however, when stock index futures were introduced in Japan in September 1988. In 1990, average daily trading volume is 1 contract, which is most likely a “decency trade” on side of those institutional investors who supported the introduction of the contract in 1987. According to Morgan Stanley and Salomon Brothers Asia, both of which reaped huge profits in 1987 by exploiting price differentials between the OSF 50 package and the Nikkei 225 Index futures in Singapore, the contract had several positive features: Not only was it at the time the only way to short the Japanese stock market, but it also offered a way to buy a basket of 50 Japanese blue-chips (by way of physical delivery) that may not have been available on the market otherwise. The rate of physical delivery was very high: 1.19% for the September 1987 contract and 0.5% for the following contracts (this compares to the 1987 average of 0.19% for the Japanese government bonds futures contract in Tokyo).

This probably reflects the fact that the other Asian stock markets, Singapore and Hong Kong, had suffered not only in terms of market volume, but also in terms of trust in the economic and political stability of the two countries. This drove market participants to Japan, even if transactions costs in Tokyo and Osaka are generally much higher (see Cabot , op. cit., 1988).

Brady , op. cit.

Ibid., p. 59.

Ibid., p. 60.

In December 1987, after a long discussion it was decided to trade stock index futures at the stock exchanges instead of creating a new futures exchange; the system was decided upon before the Brady report was published. The disadvantage of the system is that the stock exchanges do not provide for a clearing institution, and therefore stock index futures in Japan are traded without a clearing house. This led to discontentment on the side of banks and the Bank of Japan who were in favor of a solid clearing and guarantee mechanism. In June 1989, the banks opened a futures exchange for interest futures with a full-fledged clearing mechanism (see Schaede , op. cit., 1990 for details).

History shows that this could happen: When the Japanese stock market crashed in 1965, the Bank of Japan bailed out the then largest securities company, Yamaichi Securities. Because the Bank of Japan acted upon the advice of the Ministry of Finance, this leads back to the discussion of a unified regulatory agent rather than to discussions on the credit mechanism.

CME, op. cit., pp. 44–46.

Margin requirements for Japanese stock index futures (Tokyo, Osaka) were increased to 10% for exchange members and 15% for indirect investors in August 1990.

CME, op. cit., p. 51.

Trading on the NYSE is halted for one hour if the Dow-Jones Index falls more than 250 points below the previous day's closing price, and for two hours if it falls more than 400 points on that same day. Trading in S&P 500 futures at the CME is interrupted if the contract declines for 12 points below the previous day's close.

It should be noted that this effect, of course, is artificial. The fact that the “market price” must stop at a certain limit does not mean that the “real price” stops at the same level. Therefore, price limits in Japan prevented book losses in 1987. When there is program trading, however, price limits may prevent real losses.

Brady , op. cit., pp. VI-32.

Kyle , op. cit.