Why do
bad
things happen? The poet T.S. Eliot said that "April is
cruelest month," but for
stockbrokers, it has always been October (Despite
the fact that THIS October has been one of the best ones
for the stock market in years). This month ushers in the
fourth financial quarter of the year and it often brings
financial meltdowns with it. Why is the tenth month of the
year more prone to stock market crashes than others?
Economics professor Stephen Williamson says there's little
evidence to support that the next big crash will occur this
month just because the last three major crashes happened in
October. He says, "Stock market crashes have occurred
sufficiently infrequently in history that there is not enough
evidence on when they are more likely to occur."
Nevertheless, he has three theories on why the stock market
might tend to crash in October.
The first is the Spurious Correlation Theory. Williamson
says, "Crashes could be completely random events, and if
there are few of them, there is a high probability that all of
them will occur in October (or April or June or whatever)."
An example of a "spurious correlation" or random events is
this: "I could observe the behavior of 100 dogs. Suppose that
I get 100 people to watch the 100 dogs for a week, and
every morning just before the stock market opens, these
people observe whether the dogs are scratching themselves.
Chances are that I will be able to find one of these dogs
(call him George) who will have scratched himself every day
when the market went up, and did not scratch himself when
the market went down. Now, I would certainly be considered
a fool to bet on the stock market going up on days when
George scratches himself. In the same way, I might be foolish
to bet on stock market crashes in October."
The second is the Ripening Pumpkin Theory: "It could be that
there is something fundamental about October that causes
crashes. Could ripening pumpkins cause market crashes? Is
there something in the air from falling leaves that weakens
financial fundamentals? Not likely."
So we're left with the Sunspot Equilibrium Theory: "In some
economic models, there can exist a 'sunspot equilibrium,'
which has the feature that, if everyone coordinates on some
observable event that does not matter in any fundamental
way (like October), then this can have an influence on real
events. For example, it could be that, if everyone believes
that October is a bad month for the stock market, then this
is a self-fulfilling prophecy. General pessimism drives down the
stock market for no good reason. There are some special
conditions required for sunspot phenomena. This is a
possibility, but I don't think it's likely."
So why DOES this happen? If an economics professor doesn't
know, we're not likely to figure it out either, but if Williamson
had to choose, he says he would put his money on the
Spurious Correlation Theory. In other words, it's just a
coincidence (or what we might call a
synchronicity).
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