To discover the reasons for the October 13, 1989 crash, survey researcher William Feltus and I carried out a telephone survey of 101 market professionals on the Monday and Tuesday following the crash. We asked, "Did you hear about the UAL news before you heard about the market drop on Friday afternoon, or did you hear about the UAL news later as an explanation for the drop in the stock market? " Only 36 percent said they had heard about the news before the crash; 53 percent said they had heard about it afterwards as an explanation for the drop; the rest were unsure when they had heard about it. Thus it appears that the news story may have tagged along after the crash, rather than directly caused it, and therefore it was not as prominent as the media accounts suggested.

We also asked the market professionals to interpret the news story. We queried, "Which of the following two statements better represents the view you held last Friday?

"1. The UAL news of Friday afternoon will reduce future takeovers, and so the UAL news is a sensible reason for the sudden drop in stock prices."

"2. The UAL news of Friday afternoon should be viewed as a focal point or attention grabber, which prompted investors to express their doubts about the market."

Of the respondents, 30 percent chose statement 1 and 50 percent chose statement 2; the rest were unsure. Thus they were mostly reacting to the news as an interpretation of the behavior of investors. It may be correct to say that the news event was fundamental to this stock market crash, in that it represented a "story" that enhanced the feedback from stock price drops to further stock price drops, thereby preserving the feedback effect for a longer period than would otherwise have been the case. Yet it was unlikely to have been the cause of the crash.

Slow News Days

We can also look at days of unusually large price movements and ask if there were exceptionally important items of news on those days. Following up on Niederhoffer's work, in 1989 David Cutler, James Poterba, and Lawrence Summers compiled a list of the 50 largest stock market movements in the United States since World War II, and for each tabulated the explanations offered in the news media. Most of the so-called explanations do not correspond to any unusual news, and some of them could not possibly be considered serious news. For example, the reasons given for large price movements included such relatively innocuous statements as "Eisenhower urges confidence in the economy," "Further reaction to Truman victory over Dewey," and "Replacement buying ofter earlier fall."

Some would argue that perhaps we should not expect to see prominent news on days of big price changes, even if markets are working perfectly. Price changes in a so-called efficient market occur, so the argument goes, as soon as the information becomes public; they do not wait until the information is reported in the media. Thus it is not surprising, according to this line of reasoning, that we often do not find new information in the newspaper on the day of a price change: earlier information, appearing to the casual observer as tangential or irrelevant, has already been interpreted by perceptive investors as significant to the fundamentals that should determine share prices.

Another argument advanced to explain why days of unusually large stock price movements have often not been found to coincide with important news is that a confluence of factors may cause a significant market change, even if the individual factors themselves are not particularly newsworthy. For example, suppose certain investors are informally using a particular statistical model that forecasts fundamental value using a number of economic indicators. If all or most of these particular indicators all point the same way on a given day, even if no single one of them is of any substantive importance by itself, their combined effect will be noteworthy.

But both of these interpretations of the fact that news and market movements are only tenuously related are based on the assumption that the public is paying continuous attention to the news. By these interpretations, the public is supposed to be reacting sensitively to the slightest clues about market fundamentals or is continuously adding up all the pieces of evidence. But that is not the way public attention works; attention is much more quixotic and capricious. The news functions more often as an initiator of a chain of events that fundamentally changes the public's thinking about the market.

Attention Cascades

The role of news events in affecting the market seems often to be delayed. Attention may be paid to facts that are already well known. The facts may have been ignored or judged inconsequential in the past but attain newfound prominence after some news event. These sequences of attention may be called cascades, as one attention-getting event leads to more.

On January 17,1995, for example, an earthquake measuring 7.2 on the Richter scale struck Kobe, Japan; it was the worst earthquake to hit urban Japan since 1923. The reaction of the stock markets of the world to this event provides an interesting case study since in this case we know that the precipitating event, the earthquake, was truly exogenous and not itself generated by human activity, business conditions, the subtle hints of economic change, or the result of a confluence of unusual values of conventional economic indicators.

The earthquake took 6,425 lives. According to estimates by the Center for Industrial Renovation of Kansai, the total damage caused by the earthquake was about US$ 100 billion. The reaction in financial markets was strong, but delayed. The Tokyo stock market fell only slightly that day, and prices of construction-related companies generally rose, reflecting the expected increased demand for their products and services. Analysts reported at that time that the probable effects of the earthquake on corporate value were as yet ambiguous, since the wave of rebuilding after the quake might stimulate the Japanese economy.

The biggest reaction to the earthquake did not come until a week later. On January 23, the Japanese Nikkei share index fell 5.6 percent on no apparent news except the gradual unfolding of numerous news accounts of earthquake damage. Over the ten days following the earthquake, the Nikkei lost over eight percent of its value. If viewed as the direct result of the earthquake damage alone, the loss of value would be an overreaction.