In the first of a series of studies of Black Monday, four consultants hired by the Chicago Mercantile Exchange concluded yesterday that stock index futures traded on the CME did not cause or exaggerate the Oct. 19 stock market collapse.
The consultants said no changes in government regulation are needed, rejecting virtually all the market rules changes being discussed by the half-dozen other groups looking into the collapse. Even proposals to limit daily price changes in stock index futures, which are being floated by the exchange itself, were rejected by the study group as unnecessary.
The panel exonerated both index arbitrage and portfolio insurance, two computer-driven techniques for trading stocks and stock index futures contracts that other market observers have faulted.
The report revealed that index arbitrage and portfolio insurance together may have produced as much as 60 percent of stock index futures sales on Oct. 19. New York Stock Exchange officials had said they believed the heavy dumping of stock futures set off a cascade of stock sales that drove prices lower than they might have gone. But the study said stock index contracts "probably reduced the pressure on the NYSE, rather than increasing it."
"We have found no convincing evidence that equity futures caused the crash or that the CME handled the emergency improperly," said the panel members -- John Hawke, a partner in the Washington law firm of Arnold & Porter, and professors Merton Miller of the University of Chicago, Myron Scholes of Stanford University and Burton Malkiel of Yale University.
"Index arbitrage does not appear to have played a major role in the crash," the study said. "Portfolio insurance did contribute significantly to selling in the futures markets. However, this strategy was only one of many sources of selling, and does not by itself explain the magnitude of the crash."
Index arbitrage is a technique for taking advantage of differences in the price of stocks and stock index futures by simultaneously buying in one market and selling in the other. Portfolio insurance is a way of rapidly switching investments back and forth between risky stocks and safe government securities by using stock index futures.
But portfolio insurance failed to protect investors against losses because stock index futures prices dropped too fast, the report said, agreeing with earlier assessments. "Now that this flaw has been widely exposed, we expect that excessive use of this strategy will no longer be a problem," the panel said.
CME officials and the Futures Industry Association have suggested limiting daily changes in stock index futures prices, and perhaps stock prices, as a way of reducing market volatility and allowing traders to "take a breather" when prices are falling rapidly.
But the panel rejected that suggestion saying, "price limits serve to shut down a market at the very time that users have the greatest need."