An Equilibrium Model of the Crash

Fischer Black theorizes that investors' tastes had been changing, in that they were tolerating higher levels of risk at various levels of income than before. He also assumes that investors' estimates of mean reversion, that is, the change in the market's expected return following a change in the level of the market, were growing more slowly than actual mean reversion before the crash. When investors realized their error, he believes, they reduced their estimates of expected return and cut their holdings of stocks.