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 tulips
 Garber 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 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

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
 1634:
1.5
 July 1636: 2
 Feb 1637: 4.25
gram)
Common Bulb
Oudenaerden
 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
 First
week of Feb, 1637
 Bulb trading ends
 Markets formally shut down in April
 Prices hard to find
Some Price Falls

Witte Croonen (Guilders/1/2 lb.)
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
Jan 1637: 64
Feb 5, 1637: 1668
1642 or 1643: 37.5
Depreciation 76%
General Rotgans (Guilders / bulb)

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Feb 1637: 805
1642 or 43: 138
Depreciation 35%
Later Data
 Rare
bulb cycles
 Garber 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 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



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 1200
July 20: 1000 1000
800
Nov 1: 150
600
400
200
0
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 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
 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 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 prices
 Expansion of credit
 Some “logic” to beliefs


Sensible beginnings
Total craziness at the end (uninformed
speculation)
 Economic
impact??