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”“X” just like tulipsGarber is not so sure on this

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

Before 1634: Professional growers onlyFlowers cultivated in JuneMarkets from September - June are

futures marketsDelivery in JuneMost formal markets 1636-37Often meet in taverns

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

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

Guilders/aas(1/20 gram)1634: 1.5July 1636: 2Feb 1637: 4.25

Common BulbOudenaerden

Nov 1636: 0.075Dec 1636: 0.080Jan 19, 1637: 0.30Jan 31, 1637: 0.50Feb, 1637, max = 0.8, avg = 0.5

The Crash

First week of Feb, 1637Bulb trading endsMarkets formally shut down in AprilPrices hard to find

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

Rare bulb cyclesGarber finds that 20-30 percent

depreciations are common for very rare bulbs

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

Futures and creditsFinal (last month) frenzyTechnological foundationsHeterogeneous markets

Informed/rare: less bubble like Uninformed/common: more bubble like

Was there a 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

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

UK pounds 1720 Jan 1: 150 April 10: 300 July 20: 1000 Nov 1: 150

0

200

400

600

800

1000

1200

Jan Apr July Nov

Margin Buying

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

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

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 BubbleBreak down stock price movementsDifferent firms, and different informationWere speculators indiscriminant or,Were they following some economic

logic?

Cross Section in London Stock Exchange

South Sea increases about 10xTwo others increase more

London assurance 50x Royal exchange assurance 11x

East India Company Involved in South Asia trade Increases 3.5x

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

Some evidence for spillover from Britain to Holland

Bubbles seem to move ahead in Britain

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

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

Three Atlantic trading firms do well South Sea (up 45%) Royal Africa (up 91%) West Indies Company (up 51%)

Economic Impact

Big negative hit on insurance underwriting

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

Large increases and crashes in pricesExpansion of creditSome “logic” to beliefs

Sensible beginnings Total craziness at the end (uninformed

speculation)Economic impact??