New Evidence on the First Financial Bubble

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• Dr Rik Frehen, Tilburg University, Department of Finance
• Monday 06 February 2012, 18:00-19:30
• Castle Teaching Room, 4th floor, Cambridge Judge Business School, Trumpington Street, CB2 1AG.

If you have a question about this talk, please contact D'Maris Coffman.

The first global financial bubbles occurred in 1720 in France, Great-Britain and the Netherlands. Explanations for these linked bubbles primarily focus on the irrationality of investor speculation and the corresponding stock price behavior of two large firms: the South Sea Company in Great Britain and the Mississippi Company in France. In this paper we collect and examine a broad cross-section of security price data to evaluate the causes of the bubbles. Using newly available stock prices for British and Dutch firms in 1720, we find evidence against indiscriminate irrational exuberance and evidence in favor of speculation about fundamental financial and economic innovations in the European economy. These factors include the emergent Atlantic trade, new institutional forms of risk sharing and the innovative potential of the joint-stock company form itself. These factors ultimately had long-lasting transformative economic effects which may have been anticipated by the markets at the time. We use the cross-sectional data to test the hypothesis that the bubble in 1720 was driven by innovation by dividing the London share market into “old” and “new” economy stocks. We find that firms associated with the Atlantic trade and with the new joint-stock insurance form had the highest price increases and had return dynamics consistent with current models of “New Economy” stocks. New, high frequency data allow us to pinpoint the date of the 1720 crash and track its international propagation.

This talk is part of the Financial History Seminar series.

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