Famous First Bubbles

Before economists relegate a speculative event to the inexplicable or bubble category, we must exhaust all reasonable economic explanations. Among the “reasonable” or “market fundamental” explanations I would include the perception of an increased probability of large returns. The perception might be triggered by genuine economic good news, by a convincing new economic theory about payoffs, or by a fraud launched by insiders acting strategically to trick investors. It might also be triggered by uninformed market participants correctly inferring changes in the distribution of dividends by observing price movements generated by the trading of informed insiders. While some of these perceptions might in the end prove erroneous, movements in asset prices based on them are fundamental and not bubble movements. I aim in these pages to propose market fundamental explanations for the three most famous bubbles: the Dutch tulipmania (1634–37), the Mississippi Bubble (1719–20), and the closely connected South Sea Bubble (1720). Though several authors have proposed market fundamental explanations for the well-documented Mississippi and South Sea Bubbles, these episodes are still treated in the modern literature as outbursts of irrationality.