1. Classic Bubbles Fin254f: Spring 2010 Lecture notes 2.1

2. Three Classic Bubbles  Tulips (Holland, 1634-37)  Mississippi Bubble (France, 1719-20)  South Sea (UK, 1720)

3. 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

4. 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

5. 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

6. 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

7. 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

8. Rare Bulb Example: Admiral van der Eyck  Guilders/aas(1/20 gram)  1634: 1.5  July 1636: 2  Feb 1637: 4.25

9. 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

10. The Crash  First week of Feb, 1637  Bulb trading ends  Markets formally shut down in April  Prices hard to find

11. 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%

12. Later Data  Rare bulb cycles  Garber finds that 20-30 percent depreciations are common for very rare bulbs

13. 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?

14. 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?

15. 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

16. 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

17. South Sea Share Prices  UK pounds 1720 Jan 1: 150 April 10: 300 July 20: 1000 Nov 1: 150

18. Margin Buying  Investors able to buy on 10 percent margin in most of this period

19. 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”

20. 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

21. 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?

22. 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

23. 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

24. Timing  Some evidence for spillover from Britain to Holland  Bubbles seem to move ahead in Britain

25. Cause of the Crash  Bubble act  Insurance problems Loss of fleet of 12 ships off Jamaica Burglary of a director’s house

26. 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

27. Final Returns over 1720  Three Atlantic trading firms do well South Sea (up 45%) Royal Africa (up 91%) West Indies Company (up 51%)

28. Economic Impact  Big negative hit on insurance underwriting

29. 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.”

30. 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??