Should the stock markets be closed?

In the space of a month, the Paris Stock Exchange's flagship index, the CAC 40, lost almost 40% of its value. This drop is not (yet) as significant, but much more rapid than during the subprime crisis (-58% between June 2007 and March 2009) or the bursting of the Internet bubble (-65% between September 2000 and March 2003). The same question arises everywhere: should we close the purses?

The CAC 40 index lost almost 40% of its value between February 19 and March 18, 2020. Author

The Covid-19 epidemic will have very serious economic repercussions, that's for sure. It is no longer just the tourism sector that is being hit hard. The whole world economy is seized up and, in this context, even if the stock markets have taken a little time to react, it is logical that the stocks on the stock market lose as much their value and that the markets are so volatile.

Market overreaction

The extent of the decline remains impossible to estimate precisely, as there are so many unknowns. But experience shows that the stock markets tend to overreact, whether it's good news or bad news for that matter.

The objective of a possible closing of the stock markets is therefore not to prevent the fall, but to try to contain the fall and reduce excessive volatility.

The last time that the Paris Bourse had to close was in May 1968, due to the student protest, but especially because of a fire which ravaged the Brongniart Palace on May 24, 1968.

Previously, you have to go back to World War II for the Paris stock exchange to be closed. But all this was before the creation of the CAC 40 and the financial change. Other, more recent examples may, however, help us.

In September 2001, following the attacks, the New York stock exchange closed for a week, while the Asian and European stock exchanges continued to operate.

An academic article published in 2004 compared the reaction of the ten main stock markets in the world. However, the decline was smallest in the North American markets.

Is this directly linked to the stock market closure? Possible, but we cannot exclude other explanations. According to the authors, the size of the American market, by far the largest in the world, was a factor of resilience, and the patriotic impulse which followed the drama would have limited the sales of investors in the United States.

Such cases are rare (fortunately) and our knowledge of the impact of the closing of the stock markets is limited.

One way to approach the issue is to examine the case of a scheduled outage. What happens when the market is closed for the night, the weekend, the holidays or the lunch break? Studies seem to show that changes in stock prices are less, but cannot exclude that it is simply linked to economic activity itself slowed down during these periods. A few articles have also looked at the rare episodes of exceptional closing of the stock market, for example due to the interruptions of satellite communications in India, which were frequent until 2008. Again, it would seem that the markets are generally less volatile, but these results are difficult to generalize.

Circuit breaker mechanisms

We can finally focus not on closing the stock market as a whole, but on listing interruptions. Since the crash of October 1987 (Wall Street had then lost more than 20% in a single session, dragging most of the world markets in its wake), the stock exchanges have all implemented cut-out mechanisms with a temporary interruption , of the order of ten minutes, in the event of a sudden rise or fall in the price of a share.

The objective remains to limit panic and prevent automatic trading software from getting carried away. Overall, these circuit breakers seem to be rather effective in limiting market over-reaction, provided, however, that they can be triggered simultaneously on all trading platforms.

So, should we close the purses in the case of the Covid-19 pandemic? Past experience shows that temporary market suspension can be an effective tool. But this requires coordinated action.

Above all, we have no experience of an interruption that could last several weeks. To imagine that the authorities jointly decide to close the stock exchanges, the uncertain evolution of the pandemic does not allow us to know how long.

In addition to the circuit breaker mechanisms, the temporary ban on short sales decided by the Autorité des Marchés Financiers (AMF) limits speculation and the biggest falls for the moment. And in the case of an even more violent fall, it is always possible to extend the duration of the circuit breakers from a few minutes to a few hours, or even to limit trading sessions to one or two quotes per day.

The sharp drop in the stock markets observed in recent weeks is a reflection of fears linked to the health situation and the economic slowdown. In itself, the complete closure of the purses would only be a bandage on a wooden leg.

The Conversation _______

By Gunther Capelle-Blancard, Professor of Economics (Center d'Economie de la Sorbonne and Paris School of Business), University of Paris 1 Panthéon-Sorbonne

The original version of this article was published on The Conversation.