Classic bubbles
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Classic Bubbles. Fin254f: Spring 2010 Lecture notes 2.1. Three Classic Bubbles. Tulips (Holland, 1634-37) Mississippi Bubble (France, 1719-20) South Sea (UK, 1720). Tulip Bubble in Economic Lore. Key story of irrational speculation Indicative of completely crazy pricing “Tulipmania”

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Classic Bubbles

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Classic bubbles

Classic Bubbles

Fin254f: Spring 2010

Lecture notes 2.1


Three classic bubbles

Three Classic Bubbles

  • Tulips (Holland, 1634-37)

  • Mississippi Bubble (France, 1719-20)

  • South Sea (UK, 1720)


Tulip bubble in economic lore

Tulip Bubble in Economic Lore

  • Key story of irrational speculation

  • Indicative of completely crazy pricing

  • “Tulipmania”

  • “X” just like tulips

  • Garber is not so sure on this


Tulip history

Tulip History

  • Holland 1593-1637

  • Tulips infected with virus

    • Causes spectacular colors in infected tulips

    • Cannot be propagated through seeds

    • Only from buds of mother bulb (limited supply: 1-2 per bulb)

    • Weakens bulbs too

  • Relatively rare


Bulb markets 1634 37

Bulb Markets: 1634-37

  • Before 1634: Professional growers only

  • Flowers cultivated in June

  • Markets from September - June are futures markets

  • Delivery in June

  • Most formal markets 1636-37

  • Often meet in taverns


Futures nature of trading

Futures Nature of Trading

  • Purchase contract for later delivery (June)

    • Some uncertainty as to the exact structure

  • Small initial amount down (about 1/40 contract price)

  • Make or lose depending on eventual spot

  • Differences from futures

    • No margins: positions can be very large

    • No marking to market


Two markets

Two Markets

  • Very rare bulbs

    • Serious/informed traders

    • Markets go for entire period

    • Often just spot (not futures)

  • More common bulbs

    • Start in late (November) 1636

    • Traded by a wide range of people


Rare bulb example admiral van der eyck

Rare Bulb Example:Admiral van der Eyck

  • Guilders/aas(1/20 gram)

  • 1634: 1.5

  • July 1636: 2

  • Feb 1637: 4.25


Common bulb oudenaerden

Common BulbOudenaerden

  • Nov 1636: 0.075

  • Dec 1636: 0.080

  • Jan 19, 1637: 0.30

  • Jan 31, 1637: 0.50

  • Feb, 1637, max = 0.8, avg = 0.5


The crash

The Crash

  • First week of Feb, 1637

  • Bulb trading ends

  • Markets formally shut down in April

  • Prices hard to find


Some price falls

Some Price Falls

  • Witte Croonen (Guilders/1/2 lb.)

    • Jan 1637: 64

    • Feb 5, 1637: 1668

    • 1642 or 1643: 37.5

    • Depreciation 76%

  • General Rotgans (Guilders / bulb)

    • Feb 1637: 805

    • 1642 or 43: 138

    • Depreciation 35%


Later data

Later Data

  • Rare bulb cycles

  • Garber finds that 20-30 percent depreciations are common for very rare bulbs


Economic impact

Economic Impact

  • Rare bulb price increases had little impact on general agriculture

  • Common bulb increases occurred after planting (Sept 1636)

  • Did Holland go into recession?


Key points

Key Points

  • Futures and credits

  • Final (last month) frenzy

  • Technological foundations

  • Heterogeneous markets

    • Informed/rare: less bubble like

    • Uninformed/common: more bubble like

  • Was there a bubble?


2 south sea bubble

2. South Sea Bubble

  • Stock market event of 1720

  • Sister bubble in Mississippi company

  • Both show big run ups in stock price and eventual crashes


Technology changes

Technology Changes

  • South Sea and Mississippi both issue shares in exchange for government debt (UK and France)

  • Set to exploit trade with Americas

    • Spanish withdrawing

  • First publicly traded insurance companies appear


South sea share prices

South Sea Share Prices

  • UK pounds 1720

    • Jan 1: 150

    • April 10: 300

    • July 20: 1000

    • Nov 1: 150


Margin buying

Margin Buying

  • Investors able to buy on 10 percent margin in most of this period


Ipo bubble starts

IPO Bubble Starts

  • Lots of great stories

    • Crazy companies: Sunlight from cucumbers

    • “A company for carrying on an undertaking of great advantage, but nobody to know what it is”


Bubble act

Bubble Act

  • June 1720: Parliament passes “bubble act”

  • New firms need to be approved by parliament

  • Tries to stop new fraudulent companies

  • Enforced at end of August 1720

  • Downward pressure on new companies

  • Unwinding margin buyers drives liquidity scramble

  • South Sea company falls too


Frehen et al new evidence on the first financial bubble

Frehen et al.New Evidence on the First Financial Bubble

  • Break down stock price movements

  • Different firms, and different information

  • Were speculators indiscriminant or,

  • Were they following some economic logic?


Cross section in london stock exchange

Cross Section in London Stock Exchange

  • South Sea increases about 10x

  • Two others increase more

    • London assurance 50x

    • Royal exchange assurance 11x

  • East India Company

    • Involved in South Asia trade

    • Increases 3.5x


Dutch shares

Dutch Shares

  • Dutch East Indies company

    • Moderate increase (10 percent)

  • Dutch West Indies company

    • Increases by 10x

  • Investors again value Atlantic trade

  • Similar patterns to London market

  • Economic causes, financial integration(timing)

  • If bubble then not local


Timing

Timing

  • Some evidence for spillover from Britain to Holland

  • Bubbles seem to move ahead in Britain


Cause of the crash

Cause of the Crash

  • Bubble act

  • Insurance problems

    • Loss of fleet of 12 ships off Jamaica

    • Burglary of a director’s house


More on dutch firms

More on Dutch Firms

  • Dutch firms did not purchase government debt

  • That could not be the cause for their price rise

  • Suggest it might not have that much to do with either the South Sea or Mississippi bubbles either


Final returns over 1720

Final Returns over 1720

  • Three Atlantic trading firms do well

    • South Sea (up 45%)

    • Royal Africa (up 91%)

    • West Indies Company (up 51%)


Economic impact1

Economic Impact

  • Big negative hit on insurance underwriting


Fun quote sir isaac newton

Fun Quote: Sir Isaac Newton

  • Newton was one of the losers in the South Sea Bubble

  • “I have learned to predict the movement of celestial bodies but not the movement of man in markets.”


Early bubbles summary

Early Bubbles: Summary

  • Large increases and crashes in prices

  • Expansion of credit

  • Some “logic” to beliefs

    • Sensible beginnings

    • Total craziness at the end (uninformed speculation)

  • Economic impact??


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