Working Paper: NBER ID: w15332
Authors: Rik GP Frehen; William N Goetzmann; K Geert Rouwenhorst
Abstract: The first global financial bubble in stock prices occurred 1720 in Paris, London 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 examine a broad crossâsection of security price data to evaluate the causes of the bubbles. Using newly collected stock prices for British and Dutch firms in 1720, we find evidence against indiscriminate irrational exuberance and evidence in favor of speculation about two factors: the Atlantic trade and the incorporation of insurance companies. We study the role of innovation in the insurance market by examining market betas and volatilities of new insurance company shares, like (Pastor & Veronesi, Technological Revolutions and Stock Prices, 2009). We find strong evidence for a revolution in the insurance business in 1720. Our findings are consistent with the hypothesis that financial bubbles require a plausible story to justify investor optimism.
Keywords: financial bubbles; investor expectations; Atlantic trade; insurance market; historical analysis
JEL Codes: G01; G15; N13; N15
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| speculation about the Atlantic trade (N71) | investor expectations (D84) |
| investor expectations (D84) | stock prices of companies engaged in Atlantic trade (N21) |
| financial innovations in the insurance market (G22) | investor beliefs (G41) |
| insurance companies (G22) | optimism regarding risk-sharing and capital formation (G24) |
| optimism regarding risk-sharing and capital formation (G24) | stock prices of insurance companies (G22) |
| speculation about the Atlantic trade (N71) | stock prices of companies engaged in this trade (G13) |