Why is the Recent Financial Crisis a ''Once-In-A-Century' Event?

Abstract

In the recent financial crisis, the Dow Jones stock market index dropped about 54% from a high of 14164.53 on October 9, 2007 to a low of 6547.05 on March 9, 2009. Alan Greenspan calls this a 'once-in-a century' crisis. While we do not know how he drew his conclusion, we show that the probability of a stock market drop of 50% from its high within a century is about 90% based on the popular random walk model of the stock prices. With a broad market index of the S&P500 and a more sophisticated asset pricing model which captures more risks in the economy, the probability rises to above 99%. The message of this paper is that a market drop of 50% or more is very likely in long-run stock market investments, and the investors should be prepared for it.

Keywords: financial crisis, Once-in-a-Century event, drawndown probability

JEL Classification: G1