Famous First Bubbles: South Sea Company and Mississippi Company
Famous First Bubbles: South Sea Company and Mississippi Company
Famous First Bubbles: South Sea Company and Mississippi Company
COMPANY
EVAGELIA TSANTILA
CONTENT
Mississippi Company
Overview of the episode
Rationality
Role of equity and government
South Sea Company
Overview of the episode
Financial operations
Price collapse
Rationality
Role of options
Conclusions
Questions
ECONOMIC FRENCH ENVIRONMENT
18th century French economy was depressed-high
debt-high taxes
Two components:
1)Conversion of public debt
into government equity
2)Replacement of the existing
commodity money with paper
money
LAW’S FINANCIAL ACTIONS
June 1716 : “Banque Generale”,issued bank notes
August 1717: “Compagnie d’Occident”, monopoly
on trading with Lousiana and Mississippi
January 1719: became “Banque Royale”
May 1719: “Compagnie des Indes”, monopoly
with countries outside Europe
July-October 1719: Right to mint and collect taxes
THE MOST CRUCIAL EVENTS AT 1719-
1720
“Banque Generale” and “Compagnie des Indes”
merged
Law became France’s Finance Minister
Issues of shares
Garber writes: “ There is a difference between uncertainty about the future which
drives innovators, risk-taking entrepreneurs and eventually markets and mob
psychology”
VELDE(2004)
What is the role of government equity and money in the
Mississippi share price?
“According to Scott market value of a long annuity was 1600£ prior to 3373£ after the
conversion”
17th June : 3rd subscription OPTION
OPTION
S???
S???
3)50,000 shares at 1000£
The company acquired 85% of the redeemables and 80% of the irredeemables.
SOUTH SEA BUBBLE
THE PRICE COLLAPSE
Market value of all shares
31 August:164 mil.£
1 October :61 mil.£
What were the reasons?
1)Installments from the 1st and 2nd subscription were required
2)The increase of “bubble companies” NON
like Royal Assurance and London Assurance which EXISTEN
T
tried to “steal” South Seas’s investors
LIQUIDI
3)The Bubble Act in June 1720: TY
ban the formation of unauthorized corporations
4)News about Mississippi co and Tulipmania
Garber in his own words: “The bubble interpretation has relegated the far more
important Mississippi and South Sea episodes to a description of pathologies of group
phycology”……“It is curious that economists have accepted the failure of the
experiments as proof that the investors were foolishly and irrational wrong”
SUPPORT EVIDENCE HARRISON(2001)
-Investigation in the methodology of equity valuation
at the time of South Sea
-Pamphlet press, written to influence the government
policy, criticize the stocks
-Harrison states that there were different opinions
about the “right”, the so-called “Intrinsic Value”,stock
price of SS but all of them are calculated in the same
way
-Dividend discount model: Profits were discounted at
the rate of interest, the investors were awared of the
relation between interest and asset prices
-The majority disagreed about SS’s current annual return and the
projection of future profits
Projection means : Dividends payments
Future prospects
-Harrison mentioned that high prices can be justified by the “strong
future monopoly profits”
-He also believed that:
-the conversion of government debt
-the company’s financial strength
-the support of the king and Parliament
contributed to the overvaluation of shares
In his own words: “My main point is that even if the bubble were partly
attributable to investors who neglected fundamentals, it would be wrong
to conclude that investors in 1720 were somehow less savvy or rational
than investors today.”
LITERATURE VIEWS-THE ROLE OF OPTIONS
Gary Shea(2007):
-Response to DJT article, irrationality in financial markets and
the legal formation of options
-provide us efficient proof that :shares and subscriptions of
South Sea “have built” options into them
Basic hypothesis:
Shea examines the enforcement of subscription contracts in the
relevant Act(Geo. 1, c.4 ) and found that the subscribers were
not forced to deliver the raised money
-Shea also demonstrates the size of counterparty risk in forward
financial contracting
CONCLUSIONS
Indeed both financial experiments failed.
Improvements at theoretical fundamentals