Financial markets can go mad: evidence of irrational behaviour during the South Sea Bubble

• Published in: The Economic history review Vol. 58; no. 2; pp. 233 - 271
• Main Authors: DALE, RICHARD S., JOHNSON, JOHNNIE E. V., TANG, LEILEI
• Format: Journal Article
• Language: English
• Published: Oxford, UK and Malden, USA Blackwell Publishing Ltd 01-05-2005; Blackwell Publishers
• Subjects: Business structures; Economic bubbles; Economic conditions; Economic history; Economic statistics; Investment policy; Investors; Market prices; Price premiums; Receipts; Securities analysis; Securities markets; Stock prices; Stock shares; Studies; Subscription prices; Volatility
• ISSN: 0013-0117; 1468-0289
• DOI: 10.1111/j.1468-0289.2005.00304.x

This paper explores investor behaviour during the South Sea Bubble-the first major speculative boom and bust on the stock markets. Previous literature debates whether investors during this episode acted rationally. Newly acquired data involving parallel markets for the South Sea Company's stock and subscription receipts are analysed, and widening valuation gaps are observed between these substitutable financial instruments. Rational explanations do not prove adequate, and the anomalies are explained by the biased decision-making of investors, and their tendency to view financial markets as wagering markets. The implications of these findings for the current debate on rationality in financial markets are identified.