What causes stock market crashes, from Shanghai to Wall Street
By Michael Maiello – The Shanghai Stock Exchange reached a historic peak in June 2015, and then plunged, losing almost 40 percent of its value in a month. This crash of the world’s second-largest stock market evoked comparisons to the 1929 Wall Street collapse, and provided a laboratory for testing an enduring explanation of its causes.
It has long been theorized that the 1929 crash reflected “leverage-induced fire sales,” according to University of International Business and Economics’ Jiangze Bian, Chicago Booth’s Zhiguo He, Yale’s Kelly Shue, and Tsinghua University’s Hao Zhou. They acknowledge that the theory has been well-developed to explain how excessive leverage makes investors sell in emergency conditions, accelerating market crashes. But they suggest that, until now, the empirical research has been lacking—and the China crash finally offers empirical evidence.
The researchers analyzed account-level data for hundreds of thousands of investors in China’s stock market. Because leverage was introduced in mainland China only in 2010, Bian, He, Shue, and Zhou were able to examine the implications of leverage-limiting regulations imposed in this decade. During the first half of 2015, there were two sources of leverage for Chinese investors—regulated brokerage houses and nonregulated online lending platforms. The latter, along with other nonbank lenders such as trust companies, formed the shadow-banking industry in China. The researchers thus studied the effects of each type of borrowing. more>