The Crash of ʼ87: Was It Expected? The Evidence from Options Markets



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    • The Wharton School, University of Pennsylvania. Financial support from the National Science Foundation, grant #SES-8921059, and from the University of Pennsylvania Junior Faculty Research Fund is gratefully acknowledged.


Transactions prices of S&P 500 futures options over 1985-1987 are examined for evidence of expectations prior to October 1987 of an impending stock market crash. First, it is shown that out-of-the-money puts became unusually expensive during the year preceding the crash. Second, a model is derived for pricing American options on jump-diffusion processes with systematic jump risk. The jump-diffusion parameters implicit in options prices indicate that a crash was expected and that implicit distributions were negatively skewed during October 1986 to August 1987. Both approaches indicate no strong crash fears during the 2 months immediately preceding the crash.