Risk Management: Foundations for a Changing Financial World

CHAPTER 21

BLACK MONDAY AND BLACK SWANS^u

John C. Bogle

Investors need to be aware that rare events with an extreme impact that, afterwards, we think we could have predicted—in short, black swans—happen in the markets. Those who are trying to measure risk in the financial markets need to carefully distinguish risk, with its probabilities, from uncertainty, which cannot be measured. We have become increasingly vulnerable to black swans because our financial economy has come to play an ever-larger role in our productive economy.

The 20th anniversary of what came to be known as “Black Monday”—19 October 1987—provides a memorable platform for considering, yet again, the role of risk in our financial markets. On that single day, the Dow Jones Industrial Average dropped from 2,246 to 1,738, an astonishing decline of almost 25 percent, nearly twice the largest previous daily decline of 13 percent. The 13 percent decline, which took place on 24 October 1929—known as “Black Thursday”—proved to be a distant early warning that the Great Depression lay ahead.¹

From its earlier high in late August 1987 until the stock market at last closed on that fateful Black Monday, some $1 trillion was erased from the total value of U.S. stocks. The stunning decline shocked nearly all market participants, although some veterans were not surprised. For example, Alan (“Ace”) Greenberg, former chairman of Bear Stearns Companies, was quoted in the newspapers as saying, “So markets fluctuate. What else is new?” ...