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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

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??