Tuesday, October 16, 2007

Why These Historical Patterns?

A number of blogs have pointed to some interesting patterns in the history of financial markets: the month of October (1929, 1987, 1997) and years ending in 7 (1837, 1847, 1907,1987,1997, 2007) seem prone to financial crises. These patterns may be purely coincidental or they may reflect some real economic phenomenon yet to be discovered. In any event, below are two blogs commenting on these patterns.
As experts look back at 20th anniversary of the stock market’s Black Monday crash, some questions remain about why October has been a common month for major declines. The reasons aren’t clear, but Federal Reserve Chairman Ben Bernanke has offered one possible explanation.

In today’s
retrospective of the 1987 crash, the Journal’s E.S. Browning notes, “For reasons analysts don’t fully understand, October has been the month for market crashes and other sudden drops. It was in October that stocks crashed in 1929, falling 23% over two days. On Oct. 27, 1997, within a day of the anniversary of the 1929 crash, the Dow Jones Industrial Average fell 7.2%, for a drop of 13% in two months.”

Mr. Bernanke commented on the phenomenon in a 2005 interview with Randall Parker, an economics professor at East Carolina University, about the Great Depression. “Classically, October has always been the month for financial problems,” Mr. Bernanke said. “If you look at the reasons for the Federal Reserve Act in the beginning, one reason was to provide an elastic currency. The main purpose of an elastic currency was to provide extra money as needed during periods of harvest or planting which in turn was intended to keep short-term interest rates more stable,” Mr. Bernanke said. “The high short-term interest rates during the fall and the spring created a shortage of liquidity and often provided the backdrop in which banking panics would take place.”

Although, it’s hard to understand why this should still be the case when agriculture has become such a smaller part of our economy. Perhaps, people just can’t let go of harvest traditions, whether they be jack-o-lanterns or banking panics.
A lot of people have compared the recent financial crisis to the crisis of 1907. It’s interesting that the time difference is exactly 100 years, but it’s easy to call that a coincidence. The modern economy hasn’t been around long enough, hasn’t provided enough data to say whether the 7th year of a century has been a more likely occasion for a financial crisis, and there’s no particular reason (that I know of) to think that it would be. But it’s vaguely interesting that both years end in 7: there are enough years ending in 7 that one could look for a correlation in the actual data if one thought there were any point in doing so.
The story gets more interesting in the light of a piece by financial historian Harold James (hat tip: Greg Mankiw). Without any apparent inclination to look specifically for sevens, he comes up with three years that he thinks are better parallels for 2007: they are 1837, 1847, and 1857. Since only 1 in 10 years end in 7, the chance of pulling 3 such years by random chance is 1 in 1000. That’s looking like statistical significance, considering that we already had an empirical basis for the hypothesis that there is something special about 7. Thinking back over the last two decades, I also recall that that the great Asian financial crisis began in 1997, and the US stock market crash happened in 1987.

Perhaps this is still all coincidence, but it seems that, if someone could think of a reason why financial crises are more likely in years ending with 7, it would make sense to listen to that reason

2 comments:

  1. Or we could just be "fooled by
    randomness" as Nasseem Taleb
    might warn us!

    ReplyDelete
  2. JMK:
    I was a little reluctant to make this posting for that reason, but in the back of my mind I was wondering if something like the elusive Kondratiev waves was at work.

    I will have to conclude, uless I hear a good story to contrary, that these patterns are purely coincidental.

    ReplyDelete