Question

Discuss why Black Monday, the day when the DJIA declined more than 20%, is not evidence against the efficient market hypothesis.

Answer 1

Efficient market hypothesis implies using all the available current information reflected in the asset price. it emphasises that only new information can change the price of assets introducing the random walk process of stock prices.

The 1987 Black monday crash when the Dow jones industrial average declined by 20% which is refered as the largest decline in a day in US history. Also, NASDAQ crashed in march 2000 fell by around 60%.

One thing to note is that short term fluctuations in prices of stocks caused by institutional factors do not contradict the basic reasoning of efficient market hypothesis.

These shocks emphasis the role of market psychology in determining stock prices and as long as unpredictable stock market crashes hold true, basic implications of rational expectations exist.