New Evidence on the First Financial Bubble

Stock prices' interdependence during the South Sea boom and bust

“…The South Sea Company was founded in 1711 in order to help restructure part of the British national debt and exchange debts of soldiers, sailors, and other government creditors with shares in the company (Frehen et al, 2012;Paul, 2009). 9 The South Sea Company outbid the Bank of England to win the right to buy all outstanding English government long annuities, short annuities, and redeemable debts in exchange for its own shares (Dale, Johnson, & Tang, 2005).…”

“…The rising prices of the company's shares during 1719 is directly associated with the expanding activity of the company. The Mississippi Company share prices rose by a factor of 10 in 1719 and early 1720 (Frehen et al, 2012). During the spring of 1720, the Mississippi bubble burst when Law set a high exchange ratio between equity shares and bank notes.…”

“…This paper adds to this literature by investigating stock prices' interdependence during the South Sea boom and bust of 1720. The South Sea Company share prices along with the prices of other British companies rose dramatically from January to June 1720 and remained flat for most of the summer before falling sharply in September and October of the same year (Frehen, Goetzmann, William, & Geert Rouwenhorst, 2012). This event has since been termed the South Sea bubble.…”

“…Stock prices may also have long-run relationships if some underlying economic factors systematically affect all prices and markets (Madura, 1992). According to Frehen et al (2012), although there were not many technological innovations during 1720, several different important financial innovations were implemented. The first innovation, in government finance, was converting the national debt into the corporate stock of the South Sea Company.…”

“…The fourth innovation was the attempt by corporations in Britain to pursue opportunities beyond their charter. 8 As indicated by Frehen et al (2012), these innovations helped form investor optimism during the boom of the South Sea Company during the first 6 months of 1720. Given these financial innovations and the rigorous investor activities in the new stock market, it is of interest to investigate the effect of the stock market boom and bust on the linkage between the share prices of major companies.…”