Recreating the South Sea bubble: Lessons from an experiment in financial history
AbstractMajor bubble episodes are rare events. In this paper, we examine what factors might cause some asset price bubbles to become very large. We recreate, in a laboratory setting, some of the specific institutional features investors in the South Sea Company faced in 1720. Several factors have been proposed as potentially contributing to one of the greatest periods of asset overvaluation in history: an intricate debt-for-equity swap, deferred payment for these shares, and the possibility of default on the deferred payments. We consider which aspect might have had the most impact in creating the South Sea bubble. The results of the experiment suggest that the company’s attempt to exchange its shares for government debt was the single biggest contributor to the stock price explosion, because of the manner in which the swap affected fundamental value. Issuing new shares with only partial payments required, in conjunction with the debt-equity swap, also had a significant effect on the size of the bubble. Limited contract enforcement, on the other hand, does not appear to have contributed significantly.
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Bibliographic InfoPaper provided by Department of Economics and Business, Universitat Pompeu Fabra in its series Economics Working Papers with number 1381.
Date of creation: Sep 2013
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Web page: http://www.econ.upf.edu/
Financial bubbles; experiments; South Sea bubble; risk-shifting; government debt; equity issuance;
Other versions of this item:
- Giovanni Giusti & Charles Noussair & Hans-Joachim Voth, 2013. "Recreating the South Sea Bubble: Lessons from an Experiment in Financial History," Working Papers 710, Barcelona Graduate School of Economics.
- Giusti, G. & Noussair, C.N. & Voth, H-J., 2013. "Recreating the South Sea Bubble: Lessons from an Experiment in Financial History," Discussion Paper 2013-042, Tilburg University, Center for Economic Research.
- G01 - Financial Economics - - General - - - Financial Crises
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
- G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies
- N23 - Economic History - - Financial Markets and Institutions - - - Europe: Pre-1913
- C92 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Group Behavior
This paper has been announced in the following NEP Reports:
- NEP-ALL-2013-09-26 (All new papers)
- NEP-EXP-2013-09-26 (Experimental Economics)
- NEP-HIS-2013-09-26 (Business, Economic & Financial History)
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