The 1987 crash permanently shifted the S&P options market’s implied distribution toward crash expectations.

Evidence

Jackwerth and Rubinstein have shown how to infer backward 5j from observed skews to what they imply for the probability distribution of the underlying index. Slightly left-skewed and platykurtic (flat-topped) distributions prior to the 1987 crash have been replaced by more or less consistently left-skewed and leptokurtic (more peaked and long-tailed) distributions (see fig. 2). To put it simply, the options market does not expect changes in the S&P 500 index to be log-normally distributed, and large downward movements have implied probabilities far greater than 14 Interviewees generally agreed that this was the case (with some dispute as to how flat the implied volatility-strike price relationship was prior to 1987), but the prime evidence here is econometric, not interview based. — Donald MacKenzie & Yuval Millo, Constructing a Market, Performing Theory, 143

Categorization

• ADDENDUM: Directly relevant to the reader’s finance/performativity reading purpose — post-crash pricing shows the market pricing in events the theory said couldn’t happen, a data point for how theory and market interact.
• XREF: connects to: The 1987 crash permanently broke Black-Scholes fit with market prices — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 150; The post-1987 volatility skew became a permanent feature of index options — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 901; Fat-tailed price distributions were documented decades before the 1987 crash — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 1163 (+2 more)

Related

• The 1987 crash permanently broke Black-Scholes fit with market prices (similarity 0.89)
• The October 1987 crash ended the flat volatility curve predicted by Black-Scholes (similarity 0.88)
• Fat-tailed price distributions were documented decades before the 1987 crash (similarity 0.87)
• The 1987 crash ended the Barnesian performativity of classic option-pricing theory (similarity 0.87)
• Explaining post-1987 option prices requires crash frequencies roughly four times historical rates (similarity 0.87)
• The 1987 crash ended the Black-Scholes model’s empirical fit for good (similarity 0.86)
• The 1987 crash was a multi-sigma event under the log-normal assumption. (similarity 0.85)
• The post-1987 volatility skew became a permanent feature of index options (similarity 0.85)
• Post-1987 option pricing may be rational given the crash’s trauma, not irrational. (similarity 0.84)
• Implied volatility spiked from 20 to 170 percent in the 1987 crash. (similarity 0.84)
• The 1987 crash was a 27-sigma event under the log-normal model. (similarity 0.84)
• The 1987 crash traumatized U.S. derivatives markets in ways absent elsewhere. (similarity 0.84)
• Index option prices since 1988 embed an irrational crash premium beyond any plausible expectation (similarity 0.83)
• The 1987 crash’s minimal economic impact hides how traumatic it was for market participants. (similarity 0.82)
• The post-1987 options skew was primarily an American rather than global phenomenon (similarity 0.81)

Broader Connections

• The post-1987 volatility skew became a permanent feature of index options #corroborates (0.95) — Donald MacKenzie, An Engine, Not a Camera, 901
• The 1987 crash permanently broke Black-Scholes fit with market prices #expands (0.88) — Donald MacKenzie, An Engine, Not a Camera, 150
• The 1987 crash ended the Barnesian performativity of classic option-pricing theory #expands (0.82) — Donald MacKenzie, An Engine, Not a Camera, 942
• Fat-tailed price distributions were documented decades before the 1987 crash #complicates (0.75) — Donald MacKenzie, An Engine, Not a Camera, 1163
• Widespread crash fears created a self-fulfilling prophecy in October 1987 #qualifies (0.72) — Donald MacKenzie, An Engine, Not a Camera, 859