Working Paper: CEPR ID: DP4221
Authors: Peter Temin; Hansjoachim Voth
Abstract: The efficient markets hypothesis implies that, in the presence of rational investors, bubbles cannot develop. We analyse the trading behaviour of a sophisticated investor, a London goldsmith bank, during the South Sea bubble in 1720. The bank believed the stock to be overvalued, yet found it profitable not to attack the bubble. Detailed examination of daily transactions in the London stock market shows that ?riding the bubble? was a highly profitable strategy. These findings lend support to recent theoretical work arguing that predictable investor sentiment may prevent rational investors from attacking a bubble.
Keywords: bubbles; investor sentiment; South Sea Company; speculation
JEL Codes: G12; G14; N23
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Investor sentiment (G41) | Hoares Bank's trading strategy (G21) |
| Expectation of future irrational buying (D84) | Hoares Bank's decision to invest (G21) |
| Short-selling constraints (G19) | Hoares Bank's ability to profit (G21) |
| Hoares Bank's trading strategy (G21) | Realized profits (G19) |
| Rational analysis of market dynamics (D43) | Hoares Bank's trading decisions (G21) |