Presentation on theme: "Classic Bubbles Fin254f: Spring 2010 Lecture notes 2.1."— Presentation transcript:
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 gram) 1634: 1.5 July 1636: 2 Feb 1637: 4.25
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.) 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 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 July 20: 1000 Nov 1: 150
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??