Yet they continued to hold onto their stocks and buy more because they saw a good probability that the bubble would continue to grow, bringing them large positive returns until the crash came.
They expected those returns to equal the risk-free rate available to them in other investments, plus the usual risk premium from investing in stocks in the absence of bubbles, plus returns large enough to compensate them for hanging on as long as the bubble lasted. They accepted the probability that the bubble would eventually burst and present them with a large one-time negative return, which their positive returns would exceed.
Furthermore, many sophisticated individual and institutional investors thought they could capture an abnormally high bubble premium and still get out in time, believing they were protected by ''portfolio insurance,'' a misnomer for a strategy intended to guarantee a specified minimum return.
But the strategy assumed a liquid market into which they could sell stocks whenever the need arose. The strategy worked well when the number of insurers was small, but when it swelled, and everybody wanted to get out at the same time, the liquidity of the market was destroyed, and stocks last Oct. 19 took their biggest one-day dive in history, both absolutely and relatively.
Published October 14, 1988. Maybe this is a vast conspiracy to prevent editorial authors from having to write fresh copy?
Economic Scene; The Vulnerability Of the Markets - The New York Times.
