New Evidence on the First Financial Bubble

The series of events in 1720 called the Mississippi Bubble, South Sea Bubble and the Dutch Windhandel represent the first and by some measures the largest global financial bubble in history. Stock prices of more than 50 companies rose by 100% to 800% in less than a year and then lost nearly all of their gains within two months. The question is: why? In this paper we hand-collect new, high-frequency, cross-sectional data from 1720 to test theories about market bubbles. Our tests suggest that innovation was a key driver of bubble expectations. We present evidence in contrast with the currently prevailing debt-for-equity conversion hypothesis and relate stock returns to innovations in Atlantic trade and insurance. We find evidence consistent with the innovation-driven bubble dynamics documented by Pastor and Veronesi’s (2009) for new economy stocks.

Using detailed transactions data for one major bubble company in the Netherlands we also test recent clientele-based theories about bubbles. In contrast to results for the recent tech bubble, we find no evidence that the trades of either insiders or arbitrageurs were coordinated or that they triggered the Dutch 1720 crash. We also show little evidence of arbitrageurs liquidating their positions shortly after the price collapse.